The new secondary mortgage facility, geared towards low to middle income earners, is accompanied by measures to safeguard the financial sector against a sub-prime mortgage crisis similar to that of the US, says the Jamaica Mortgage Bank (JMB)

JMB general manager Patrick Thelwell, at the launch of the facility last week, assured Sunday Finance that funding mortgages for low-income borrowers would not affect financial sector stability in the way it transpired in the US.

“One of the things we are not doing is that we are not buying the mortgage off the books of the originators, so they will continue to have an interest in the mortgage and we are buying them with recourse. So if the mortgage goes bad they will have to buy it back from us. Once the person hasn’t paid in three months, that’s considered a bad mortgage and they will have to buy it back from us,” said Thelwell.

“Because it is on their books, because they take the credit risk, they will have to write proper mortgages,” he said of the institutions.

The US sub-prime mortgage crisis, which led to plunging property prices, a slowdown in the US economy, and billions in losses by banks, stemmed from a fundamental change in the way mortgages were funded. Financial institutions would traditionally finance mortgages through customer deposits but this limited the amount of mortgage lending an institution could do and to the quality of borrowers they could lend to. The institutions therefore sold ‘sub-prime’ mortgages — those sold to borrowers who had poor credit histories and weak documentation of income and were shunned by the “prime” lenders.

The business became extremely profitable for the banks which earned a fee for every such mortgage that they sold. By 2007, at which point the crisis began, sub-prime lending had ballooned to US$2.8 trillion of the US$6 trillion mortgage market, according to the Federal Reserve, and one in five mortgages were sub-prime. The foreclosures and repossessions grew out of control when borrowers, who had already been questionable credit risks, could no longer support their mortgages as the payments on the adjustable rate mortgages grew along with the substantial increase in the level of Fed interest rates.

In the US, the banks, having sold the mortgages off their books, then had no incentive to monitor the creditworthiness of the borrower and the mortgages that they sold. With a SMM, however, the banks can now sell the mortgages to the bond markets, which has made it much easier to fund additional borrowing and by a larger group of persons at lower interest rates.

The sub-prime crisis started on the same premise as the SMM facility — to make home ownership affordable to those who cannot now afford it. But Thelwell argued that to ensure accountability, financial institutions in Jamaica would share the responsibility of the mortgages with the JMB.

“In the US what happened is that the underwriting quality dropped significantly because they could just sell it off,” Thelwell said of the banks. “We are ensuring that the underwriting quality remains high and that is how we will prevent the sub-prime,” Thelwell said.

Given that the SMM is targeting lower income earners the concern that there could be a higher risk of default was not a real one. “What we are looking to do is to lend to institutions that better understand their customers so they will be best able to structure the quantum, the term, the interest rate for that particular person. So we are leaving all of that up to the financial institution. They have been doing a good job. We are not looking to step in and take the credit risk, so that way we think the credit quality of those mortgages will be good,” Thelwell reasoned.

However at least one representative from a financial firm was not pleased with the assumption of what was deemed to be ‘all the risks’ of the mortgages. Thelwell pointed out that the JMB would assume the major risks, these being the interest rate and liquidity risks.

“The credit risk is yours, but the interest rate risk is ours,” he told a member of a mortgage company.

“There is liquidity risk, there is interest rate risk and there is credit risk. We are taking away certain risks from you. All you have is credit risk, but I have substantial interest rate risk that I have to deal with. In other words, I have lent you some money at a particular interest rate and you lend for 20 years, I am backing those with five year variable rate bonds. If interest rates go up we will have to absorb that interest rate risk over time,” he said.

Dr Horace Chang, minister of water and housing, in his address at the launch also noted the safety of the SMM where Jamaica is concerned.

“Mortgages is supposed to be one of the safest investments and every Jamaican wants to get a piece of the ‘Rock’,” said Chang.

Thelwell is confident that even with the risk that rising interest rates will affect the value of the issued bonds, the JMB is in a good position where administering the secondary mortgages are concerned.

“What we have to do is to manage that interest rate risk so part of what we have to do is set up reserves to deal with that so that we don’t pass through any rising interest rate directly onto the customer,” Thelwell said.

“But we as a country cannot afford to go back a high interest rate regime. When the debt was $500 billion, and so on we could think about it, but at $1.3-1.4 trillion to go back to a high interest rate would just devastate the country. We might see an uptick, but I don’t think we will see any significant rise in interest rates going forward.”

The secondary mortgages are now available through GSB and Churches Credit Unions at 11.95 per cent, but the JMB is in talks with other financial institutions to join the SMM.