APRA urges banks to top up reverse mortgage cover

THE bank regulator has urged lenders to keep their levels of capital topped up to cover their exposure to reverse mortgages, cautioning that these loans rank among some of the highest risk.

By InvestSMART · 7 Jul 2010

By InvestSMART ·
7 Jul 2010

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THE bank regulator has urged lenders to keep their levels of capital topped up to cover their exposure to reverse mortgages, cautioning that these loans rank among some of the highest risk.

The recommendation that banks hold more capital is likely to further pressure the fledgling $2.7 billion reverse-mortgage market, which was caught out last month when the Royal Bank of Scotland decided to shut down its Australian reverse-mortgage business.

Reverse mortgages are mostly used by older home owners to tap equity in their properties while they continue to live in them.

When banks are required to set aside more capital to cover their exposure to a loan, it dampens profitability.

If the loan is not repaid early, the principal and any accumulated interest are repaid from the proceeds of the sale of the property when the borrower dies or sells the home usually to move into a retirement village.

While reverse mortgages became more popular in the 1990s, they have accounted for less than 3 per cent per cent of outstanding housing loans.

A recent study by accountants Deloitte found the Australian reverse-mortgage market consisted of nearly 39,000 loans worth a total of $2.7 billion at the end of last year, a growth of 9 per cent over the year. This compares with a 22 per cent growth in 2008 and 33 per cent in 2007.

In a letter to bank executives, Australian Prudential Regulation Authority general manager Charles Littrell said reverse mortgages were among the most risky loans even though they were secured by properties.

"The management of a reverse-mortgage portfolio can present challenges due to the long and uncertain maturity profile of the assets," Mr Littrell said in the letter. "There are also a number of unique operational, legal and reputational risks associated with reverse mortgages."

When a reverse mortgage represented more than 60 per cent of the value of the property, banks were required to hold the maximum amount of capital to back the loan, he said.

This contrasts with a standard mortgage, where banks can set aside just a fraction of the value of the loan.

He also said that if the accumulated interest and outstanding principle of a reverse mortgage outstripped the value of the house, then the exposure had to be treated as an impaired loan.

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Frequently Asked Questions about this Article…

What did APRA recommend banks do about reverse mortgage capital cover?

The Australian Prudential Regulation Authority (APRA) urged banks to keep their levels of capital topped up to cover exposure to reverse mortgages. In a letter from APRA general manager Charles Littrell, regulators warned lenders these loans are among the highest risk and should be backed by appropriate capital buffers.

Why does APRA consider reverse mortgages high risk for banks?

APRA says reverse mortgages can be high risk because of their long and uncertain maturity profile and a range of unique operational, legal and reputational risks. Even though they are secured by property, those features make portfolio management and risk assessment more challenging.

How do reverse mortgages work for older homeowners?

Reverse mortgages let older homeowners tap equity in their property while continuing to live there. If the loan isn’t repaid early, the principal and any accumulated interest are repaid from the proceeds of the property sale when the borrower dies or sells the home, often to move into a retirement village.

How large is the Australian reverse mortgage market and how fast is it growing?

A Deloitte study found the Australian reverse mortgage market had nearly 39,000 loans worth about $2.7 billion at the end of last year, a 9% growth over the year. Historically it grew faster in earlier years (22% in 2008 and 33% in 2007), but it still accounts for less than 3% of outstanding housing loans.

How do higher capital requirements affect banks and the reverse mortgage market?

When banks are required to set aside more capital to cover reverse-mortgage exposure, it dampens profitability for lenders. APRA’s push for higher capital buffers is likely to put further pressure on the fledgling $2.7 billion reverse-mortgage market.

When must banks hold the maximum capital against a reverse mortgage?

APRA requires banks to hold the maximum amount of capital to back a reverse mortgage when the loan represents more than 60% of the value of the property. That contrasts with standard mortgages, where banks can set aside a much smaller fraction of the loan value.

What happens if accumulated interest and principal exceed the value of the house?

If the accumulated interest and outstanding principal of a reverse mortgage outstrip the value of the house, APRA says the exposure must be treated as an impaired loan, which has implications for bank provisioning and capital.

Why was the Royal Bank of Scotland’s decision to exit important for the reverse mortgage market?

The Royal Bank of Scotland’s decision to shut down its Australian reverse-mortgage business highlighted fragility in the sector and helped prompt scrutiny. APRA’s capital guidance followed that development and may add further pressure on the small but growing reverse-mortgage market.