Pretend and Extend

dopester

Graham_Devon wrote: »

Insiders say the thinking goes like this. Imagine you are a bank that has 10 mortgages on houses from the same street, each of them valued on the books at £100,000. One of the mortgage payers is in arrears. As a bank, you have the choice of repossessing the house but you know if you do so it will probably fetch only £80,000 when resold.

The problem for the lender is not just that it makes a £20,000 loss on one home but that the book value of every other house in the street also has to be adjusted. At a stroke, the bank's assets have been reduced by £200,000. In these difficult times, no bank wants to destroy the asset side of its balance sheet.

What about no.11, with the couple who own outright, who want to trade down to a retirement flat by the seaside and decides to accept an offer of £80K?

Or the nicer detached house around the corner who reduces their price from £135K, to £105K in order to move?

Lenders can't win with the policy you've outlined. You can't rescue everyone and others don't need to be rescued and will price to sell. Perhaps you can delay and slow down the final outcome it with that policy "going easy on those in arrears in an attempt to stop markets working properly", and incur even further losses.

nearlynew

It's all a f*cking game.

HPI cheerleaders say that borrowing gets easier as prices rise. So if prices have risen over the last year, why has borrowing not got easier?



We know borrowing has not got easier so the only conclusion you can draw is that prices have not risen.

michaels

On paper there are a lot more loans available with higher LTVs over the past year. Whether they are actually 'available' to typical borrowers seems less certain. With the banks trying to increase their capital (inverse reduce their loan book) it is not surprising they are cheery picking customers.

JonnyBravo

HAMISH_MCTAVISH wrote: »

Graham.

!!!!!! did you think we meant when talking non stop about balance sheet destruction?

That a secretary puts it in the shredder????:rotfl:

Can you see where you went wrong yet?

You have spoken to Graham before, you should know better.

Generali

Procrastinator333 wrote: »

Below is a link to Barclays accounts and the relevant note for the loan book:

http://www.barclaysannualreports.com/ar2009/files/Annual_Report_2009.pdf

Note 15, page 221.

I haven't worked on the accoutns of a bank before, so happy to be corrected, but it looks like the following to me:

The "gross loans" is just the outstanding value of the loan. So if person A has £82k of a mortgage left, £82k will go in here.

They then provide for impairment (or bad debts - £10.7m).

So if one house sold on a street for £80k they would not have to recognise that as the value of the loan doesn't drop. Just because the asset backing a £90k loan is only worth £80k doesn't mean the loan is not worth £90k. If they pay £90k the bank gets £90k.

They only provide for the loan if they don't think it will be repaid.

If the value of the security falls, the value for impairments rises.

You are right to say that the bank will get back 100% of the money if the loan is repaid and so on that basis it doesn't matter what the security is worth in terms of the balance sheet. However, if a bank repossesses and the house is in negative equity then the bank will not get all of its money back most likely. The more properties with loans against them that are in negative equity, the greater the chance of a loss.

Also, houses with equity in them are unlikely to be repossessed - if the owner gets into financial difficulties they can just sell rather than be repossessed.

chewmylegoff

Graham_Devon wrote: »

Interesting stuff here..

Never actually thought about it like that. Can anyone confirm if this really is an issue for lenders?

not really. loans are valued thus:

1) gross value = total capital left to be repaid

2) make a provision to reflect the fact that some of the loans might not be repaid and deduct this to give net value.

generally speaking, in a loan book, the way 2) is calculated is by reference to (i) the current rate of default rate across the book and (ii) the current rate of recovery of loans in default (NB/ this is not just the value of the house, as not all mortgages that are in arrears proceed to repossession).

(ii) is affected by house prices, therefore falling house prices will have some impact on the bad debt provision, but they aren't going to be sitting there adding up the number of houses on street and hacking off great chunks of their loan book every time a property is repossessed, because not all of the other houses on the street will be repossessed.

Procrastinator333

Generali wrote: »

If the value of the security falls, the value for impairments rises.

You are right to say that the bank will get back 100% of the money if the loan is repaid and so on that basis it doesn't matter what the security is worth in terms of the balance sheet. However, if a bank repossesses and the house is in negative equity then the bank will not get all of its money back most likely. The more properties with loans against them that are in negative equity, the greater the chance of a loss.

Also, houses with equity in them are unlikely to be repossessed - if the owner gets into financial difficulties they can just sell rather than be repossessed.

If you work on calculating or auditing the impairment of the loan books on banks then apologies and I will of course defer to your comments.

But unless you do one of those 2 things you don't know exactly how they calculate the impairment value, it is not something they are required to disclose.

My guess would be that they do something like the following:


Break their loan book out in to categories:
Not in arrers - No provision.
Up to 1 Month in arrears - Provide 20% of the difference between security and loan value.
Up to 3 months in arrears - Provided 60% of the difference between security and loan value.
Over 3 months in arrears - Provide 100% of the difference between security and loan value.

So it is a subtle point, but prices falling in themselves do not increase the impairment charge by a huge amount. It only has a large impact if the number of defaults rise at the same time.

The above is just a guess, but it is the sort of logic that is used for the construction of most impairment provisions. But like I say, if you work on this stuff directly then fair enough.

Generali

Procrastinator333 wrote: »

If you work on calculating or auditing the impairment of the loan books on banks then apologies and I will of course defer to your comments.

But unless you do one of those 2 things you don't know exactly how they calculate the impairment value, it is not something they are required to disclose.

My guess would be that they do something like the following:


Break their loan book out in to categories:
Not in arrers - No provision.
Up to 1 Month in arrears - Provide 20% of the difference between security and loan value.
Up to 3 months in arrears - Provided 60% of the difference between security and loan value.
Over 3 months in arrears - Provide 100% of the difference between security and loan value.

So it is a subtle point, but prices falling in themselves do not increase the impairment charge by a huge amount. It only has a large impact if the number of defaults rise at the same time.

The above is just a guess, but it is the sort of logic that is used for the construction of most impairment provisions. But like I say, if you work on this stuff directly then fair enough.

I don't work on this side of things although I have spent a lot of time in asset valuation and also for a couple of retail banks and you do pick things up along the way.

The biggest impact that negative equity has on a loan book is a rise in arrears as people can't sell their way out of trouble. You need to have your head checked if you are repossessed with equity in the property.

Also, AIUI at least, in banking you don't have no arrears = no provision. You have a provision taking into account average default rate of each class of mortgage that you measure. When you write a mortgage you know it will have a chance of defaulting. 125% mortgage to an FTB having a greater chance perhaps than a 30% LTV 1x income loan.

macaque_2

Graham_Devon wrote: »

Interesting stuff here..

Never actually thought about it like that. Can anyone confirm if this really is an issue for lenders?

Excellent post! It supports my theory that sub prime problems in the UK have been covered up. UK house prices are vastly higher than the US and yet people's incomes to underwrite these inflated prices are no better than the US.

The Labour government, in collusion with the banks have used every tool in the box to hide the sub prime problem (quantitative easing, low interest rates, doctored statistics, tolerance to chronic debt, BTL etc).

In 2008 the government had an opportunity to manage a house price correction in a controlled way. Instead, Gordon Brown took the catastophic decision to reinflate the bubble. We are now confronted with a crumbling housing market and not enough public funds for a second bail out.

The banks are quietly panicking. As property prices fall, the value of their assets suffer. This reduces their ability to lend. This precipitates further falls (bubbles usually overshoot on the downside) Their only solution is to deleverage as fast as possible; hence the flood of mortgage offers at very attractive interest rates but subject to large deposits.

Telephone conversation some time in the near future.

Buyer: I'm interested in 36 Acacia Avenue, is the vendor open to offers.
Estate Agent: Definitely! They are looking for offers around £600k.
Buyer: OK, my offer is £120k
Estate Agent: Thats ridiculous
Buyer: I think you are obliged to pass all offers on aren't you?
Estate Agent: I'll do it but you are wasting your time.

30 minutes later

Estate Agent: I have spoken to the vendor. Are you a cash buyer?
Buyer: Yes
Estate Agent: OK then, they will accept £250k.
Buyer: I am prepared to increas my offer to £180k if they throw in all the fixtures and fittings.
Estate Agent: I'll get back to you.

5 minutes later

Estate agent: Congratulations, the vendor said yes. You've got yourself a bargain.
Buyer: Hang on a minute. If they have accepted the offer, I must be paying too much. Let me have a think about it.