Negative Equity

inSight

14 Aug 2003

Negative Equity

Figures released today show that the number of residential mortgages in negative equity rose to 106,000 at the end of June. With the economy poised for recovery, some homeowners in negative equity may need to be allowed some breathing space. The banks may be in a position to help these homeowners - and, in doing so, to help themselves too.

There seems to be some difference of approach in how individual banks in Hong Kong deal with mortgages that are, or are likely to become, delinquent. Some banks are quite proactive in working with the borrowers in difficulty to restructure their mortgages, so that they can cope with their short-term financial difficulties, which, the banks are confident, are likely to go away as the economy recovers and the property market bottoms out. Other banks, however, are more reluctant to arrange restructuring for the mortgagors for one reason or another.

It is, of course, for individual banks to take their own credit decisions. They are supposed to know their customers and are in a better position than the banking supervisor to read the prospects of the economy and the property market. But, for what it is worth, let me take the unusual step of offering my views on the broader picture for reference by banks, as they tackle the problem of negative equity residential mortgages.

The number and the total amount of negative equity residential mortgages have been increasing as residential property prices continued to fall, exacerbated in the second quarter of this year by SARS. So the problem has got bigger, not just in terms of the number of cases and the total amount involved, but also in terms of the extent of the shortfall in the security of the mortgage loans. The latest figures show that the unsecured portion of negative equity loans is about HK$36 billion. It would have been a lot bigger had the banks not adhered to the 70% loan-to-value guideline in extending residential mortgages, so they should really congratulate themselves for being prudent. But with property prices having fallen since the peak in 1997-98 by 60% to 70% on average, the 30% cushion, useful as it has been, is gone for mortgages initiated a few years back. Indeed, many of them are now "under water", so to speak, and significantly so, with an average shortfall in security of slightly over 20% of mortgage loans in negative equity. Under the circumstances, the banks would obviously like to see property prices stabilising and possibly recovering. They are of course not in a position to influence property prices directly. But it is possible that, under present circumstances, in which the property market is suffering from a lack of activity and liquidity, their approach in dealing with mortgages in danger of becoming delinquent may indirectly have a significant bearing on property prices. This is because the number of repossessed properties (nearly 4,000 in the past 12 months) being disposed of has probably become a big enough factor on the supply side to have exerted a significant depressing effect on property prices, in particular those in the secondary market. It would, therefore, be in the interests of those banks which are not already doing so to give greater consideration to restructuring delinquent residential mortgages over foreclosure.

There is no doubt that the ability of mortgagors to service their residential mortgages has been eroded in recent years by lower incomes and higher unemployment. But the much lower mortgage interest rates, made possible by successive cuts in US interest rates and greater competition among banks in Hong Kong, have provided much relief. Barring an interest rate shock, mortgage interest rates in Hong Kong look like remaining low for a while. The economy, on the other hand, seems poised for recovery. Indeed, had it not been for SARS, the recovery would have been here already, as the pre-SARS economic performance in the first quarter of this year suggests. Other things being equal, the credit standing of the average mortgagor should, as a result, be on an improving trend. What they need is probably some breathing space to stay afloat and further to repair their household balance sheet. It could well be that a greater appreciation of their plight on the part of the banks and more readiness to discuss and organise residential mortgage restructuring would, taking a longer term and a wider view of things, be beneficial to both sides.

Joseph Yam

14 August 2003

 

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