Changes to BS2A and BS2B regarding the definition and capital treatment of residential mortgage loans

Intended changes: capital treatment of residential mortgage loans Intended changes to BS2A/B in respect of residential mortgage loans Changes to the definition of residential mortgage loan in BS2A/B Definition of residential mortgage loan: section 4.7 of BS2B and section 43(e) of BS2A. “Residential mortgage loan” means a loan secured by a first ranking mortgage over a residential property used primarily for residential purposes either by the mortgagor, or a related party of the mortgagor, or a tenant of the mortgagor. A loan may not be classified as a residential mortgage loan if the mortgaged property is predominately used for farming or commercial activities. Without limitation, a property will be considered to be predominately used for farming or commercial activity if: (i) the mortgaged property would be marketed as a farm or a commercial property; or (ii) the principal or interest payments are predominantly serviced from the income generated by the use of the property for farming or commercial activity, except where that income is rental income and the property is used for a residential purpose. For the purpose of this section, predominantly means more than 50 percent. From 1 July 2016, a residential mortgage loan must be classified as either a standard residential mortgage loan or a reverse residential mortgage loan. Prior to 1 July 2016, all residential mortgage loans are standard residential mortgage loans. The diagram below depicts the sub-classification of residential mortgage loans. A standard residential mortgage loan written on or after 1 November 2015, and from 1 November 2016 a standard residential mortgage loan written before 1 November 2015, must be further sub￾classified into either a non property-investment residential mortgage loan or a property-investment residential mortgage loan. All residential mortgage loans written before 1 November 2015 are classified as non property￾investment residential mortgage loans until 31 October 2016. Residential mortgage loans (RML) Standard RML Reverse RML Non property-investment RML Property-investment RML Ref #6114981 v2.0

2 A non property-investment residential mortgage loan is eligible for retail treatment irrespective of exposure size. A reverse residential mortgage loan may only be recognised in the residential mortgage loan category up to the value of the residential property used as security for the loan. Any excess of the loan over the property value is deducted from Tier 1 capital under section (7.3(o)/2.9(p)). The following definitions apply in respect of residential mortgage loans: “non property-investment residential mortgage loan” means a standard residential mortgage loan secured over only owner-occupied residential property. “owner-occupied residential property” means a property that meets the following criteria: (i) a natural person or related party of a natural person owns the property and one or other of these parties is the obligor under the residential mortgage loan; (ii) that natural person, or a related party of that natural person who falls within limb (c) of the definition of related party in this section, intends to occupy the property either as their principal or secondary residence (a secondary residence includes holiday homes or a second home where the natural person or related party spends significant time); and (iii) in respect of a secondary residence, no rental income is derived from that property, except to the extent that the rental income is minimal (e.g. a bach rented out for six weeks a year). “property-investment residential mortgage loan” means a standard residential mortgage loan that is not a non property-investment residential mortgage loan. “related party” for the purposes of section [4.7/43] means a person (A) that is related to another person (B) in one of the following ways: (a) A is the trustee of a trust and B is a beneficiary of the trust; (b)A is a company or unincorporated entity and B is a shareholder of, or otherwise controls, A; (c) A is the spouse, civil union or de facto partner of B; or (d)A is the estate of the spouse, civil union or de facto partner of B. “reverse residential mortgage loan” means a residential mortgage loan for which payments of principal or interest are not due in accordance with an agreed repayment schedule but rather on the occurrence of a specified trigger event, in which case the repayment of the loan is made from the proceeds of sale of the property. “standard residential mortgage loan” means a residential mortgage loan that is not a reverse residential mortgage loan. Ref #6114981 v2.0

3 Changes to definitions relevant to residential mortgage loans Section 4.150A of BS2B (equivalent changes will be made to 37 and 43 of BS2A) Changes are indicated with tracked change format. The loan-to-valuation ratio (LVR) for a residential mortgage loan is calculated by the formula: LVR = loan value/property value x 100 In the formula – “loan value” is the total amount of: (i) All claims secured by way of first ranking mortgage over residential property; (ii) The EAD amount of any off balance sheet exposures secured by way of first ranking mortgage over residential property and consistent with sections 4.155 to 4.158. Lending facilities that are not tied to nor managed as part of the residential mortgage loan and that are not normally treated as secured over the residential property, such as credit cards or personal loans, do not need to be included in the LVR calculation. “property value” – (i) for a standard residential mortgage loan or a reverse residential mortgage loan at the time of origination, is the total value of the residential property that is security for the residential mortgage loan determined under a bank’s residential property valuation policy when a residential mortgage loan is originated and, (ii) for a reverse residential mortgage loan, must be updated every three years, and at that time is given by the formula: property value = { Max (Vo , 80% x VR) if VR > Vo or { VR if VR ≤ Vo where Vo is the total value of the residential property that is security for the residential mortgage loan determined under a bank’s residential property valuation policy at the time the loan is originated, and VR is the total value determined at the most recent three-yearly update determined under the bank’s residential property valuation policy. “residential property valuation policy” means .. [retain existing text and add at the end]: for reverse residential mortgage loans requires that the property value is updated three-yearly. Delete from BS2A: … “independent valuer” means a person who is not associated with a person who has an interest in the residential property for which a valuation is made and who is: (i) a registered valuer as defined in the Valuers Act 1948; Deleted: , as at balance date, Deleted: the Deleted: the Deleted: ¶ Deleted: On and after 1 October 2014, Deleted: on a before 30 September 2014 means a policy governing how a property value is determined for a residential mortgage loan that Ref #6114981 v2.0

4 (ii) another person approved to provide valuation services by rules made under the Ratings Valuation Act 1998, or (iii) a person who meets the definition of valuer under the laws of another country, provided that the Reserve Bank has confirmed in writing to the registered bank that it considers the law of the other country to be at least as satisfactory as the requirements under the Valuers Act 1948. No change to definition of professional valuation service. Calibration The following calibrations will apply in BS2B. 4.164A For the purpose of section 4.164 Correlation (R) is determined by the loan-to-value (LVR) of the residential mortgage loan in accordance with Table 4.11A. Table 4.11A Correlation for residential mortgage loans LVR Correlation (R) Non property-investment residential mortgage loan Correlation (R) Property-investment residential mortgage loan 90% and over .21 .24 80-89% .20 .23 Under 80% .15 .17 Delete unnecessary sections: 4.164B/4.164C Table 4.11 Minimum LGD for residential mortgage loans LVR LGD Non property-investment residential mortgage loan LGD Property-investment residential mortgage loan 90% and over 38% 40% 80-89% 33.25% 35.5% 70 – 79% 28.5% 31% 60 -69% 19% 21.5% Under 60% 10% 12.5% Deleted: , on or after 30 September 2013, Deleted: - 100% Ref #6114981 v2.0

5 4.61 to the extent that exposures are secured by residential real estate the LGDs corresponding to different LVRs set out in table 4.11 (column 3) must be used unless the bank has the consent of the Reserve Bank to use its own LGD estimates. The following calibrations will apply in BS2A and the final column applies for reverse mortgages in BS2B The following risk weights are intended to apply to standard and reverse residential mortgage loans under BS2A and to reverse mortgages under BS2B (that is a standardised approach will apply to this asset class in BS2B). Table 4.xx: Risk weights for residential mortgage loans that are not 90 days past due Loan-to￾value ratio Risk weight in % Risk weight for reverse residential mortgage loan (%) If there is lender’s mortgage insurance that qualifies under section 38 If there is no lender’s mortgage insurance or lender’s mortgage insurance that does not qualify under section 38 Non property￾investment residential mortgage loans Property￾investment residential mortgage loans Non property￾investment residential mortgage loans Property￾investment residential mortgage loans Does not exceed 80 % 35 40 35 40 LVR Does not exceed 60% 50 81 to 90 % 35 50 50 70 LVR > 60% and < 80% 80 91 to 100% 50 75 75 90 LVR > 80% 100 Exceeds 100% 100 Deductions from Tier 1 capital 7(3)(o)/2.9(p) the amount to which the loan value of a reverse residential mortgage loan exceeds the value of the security for the loan that is residential property. Ref #6114981 v2.0

6 Ref #6114981 v2.0