Residential Mortgage Lending

Our Ref.:
Circulars
08 Jan 2010
Residential Mortgage Lending
B9/25C
B4/1C
8 January 2010
The Chief Executive
Banks Participating in the Mortgage Lending Survey Dear Sir/Madam, Residential Mortgage Lending It has come to my notice through recent press reports that some authorized institutions (AIs) have launched new mortgage products with very attractive terms, including a trend of increasing level of cash rebates. Mortgage lenders are reminded, once again, that they must adopt prudent pricing strategies. As mentioned in our letter of 17 September 2009 (Annex 1), AIs should ensure that their mortgage rates are sustainable on a long-term basis and provide a reasonable margin after taking into account possible loan losses and operational and administration costs. When setting their pricing strategies for mortgages, banks must be mindful of the fact that a downward adjustment of mortgage rate will lead to re-pricing pressure on existing mortgage portfolio, which could have long term adverse impact on net interest margin. In addition, banks must also ensure that they comply with the requirements set out in our circular dated 28 February 2005 (Annex 2) when offering cash rebates. I would also like to draw your attention to the guideline promulgated by the HKMA in October 2009 (Annex 3) reminding AIs to adopt prudent practices in assessing property values and borrowers' repayment ability. The HKMA will be undertaking onsite examinations to ensure compliance with prudent principles and practices when underwriting residential mortgage loans. Yours faithfully, Nelson Man Executive Director (Banking Supervision)

Encl. Annex 1 (PDF file, 130KB)
Annex 2 (PDF file, 221KB)
Annex 3 (PDF file, 137KB)
Last revision date : 13 May 2020

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Annex 1 - Residential Mortgage (RML)

HONG KONG MONETARY AUTHORITY Annex 1
香港 金 融 管理局
Y. K. Choi
Deputy Chief Executive
Our Ref.: B4/1C HEE jr
Ba#%
17 September 2009
Mr Peter Wong
Chairman
The Hong Kong Association of Banks
Room 525, Prince’s Building
Central
Hong Kong
Dear Peter,
Residential Mortgage Loans (RML)
It has come to our notice that competition on mortgage pricing has intensified recently among authorized institutions (Als) with some Als offering mortgage rates as low as P - 3.25% for the entire term of the mortgage. While mortgage pricing is a commercial decision for individual Als, we are concerned that intense market competition might have driven some Als to price their . mortgages aggressively to such an extent that they might not have given due regard to the reputation risk, interest rate risk and liquidity risk potentially associated with their pricing. Experience shows that if Als compete by offering large discounts to Prime rate during a period when the spread between Prime and HIBOR is relatively wide, a subsequent reversal of that spread to a more normal level will effectively erode their interest margin and force them to raise their Prime rate at a pace faster than that of the adjustment in the HKMA’s Base Rate (which is adjusted in tandem with the US Fed Funds Target Rate). This situation last occurred in 2005", when Als were criticised for raising their Prime rates faster than the change in the Base rate and in the deposit rates they offered to their customers. Drawing on this experience, Als should be mindful that the present intense price competition is not sustainable and could lead to consequences similar to those of 2005 if the current easy monetary conditions are reversed and the ! Base Rate (which normally moves closely in line with the US Fed Fund Target Rate) rose by 1.00% during Jun-Nov 05 from 4.5% to 5.5%, while the Prime rate of the majority of local banks increased by 1.75% during the same period from 6.0% to 7.75%. 55th Floor, Two International Finance Centre, 香港 中 環 金 融 街8號 國 際 金 融 中 心2期 55 樓 8 Finance Street, Central, Hong Kong 電話: (852) 2878 8128 傳真: (852) 2878 8130 Tel: (852) 2878 8128 Fax: (852) 2878 8130 電郵: ykchoi@hkma.gov.hk E-mail: ykchoi@hkma.gov.hk 網 址: www.hkma.gov.hk Website: www.hkma.gov.hk 電 訊 號 = ; 74776 XFUND HX Telex: 74776 XFUND HX

Prime-HIBOR spread starts to narrow. To avoid a repetition of the 2005 experience, all Als should endeavour to manage their Prime-HIBOR basis risk vigilantly by, among other things,

• pricing-in a reasonable margin to cater for basis risk,
• fixing mortgage rates having regard to the long-term average spread
  (around 390 b.p. in the last 5 years) between Prime and HIBOR, rather than by reference solely to the prevailing market spread (around 500 b.p. for Als whose Prime rate is 5.25% or 475 b.p. for others whose Prime rate is 5%), which is exceptionally wide and can change rapidly, and
• developing appropriate stress tests to assess the impact on funding
  cost as well as interest margin in the event that the Prime/HIBOR spread returns to a normal level. Another important consideration in this regard is Als’ liquidity management under stressed liquidity situations, when Als might have to make use of their RMLs to obtain liquidity through different channels such as securitisation, sale to a third party or pledge with the HKMA as collateral for Lender of Last Resort support (provided that the pre-conditions and criteria for such support are met). In this context, it is important for Als to ensure that their RMLs are reasonably priced so that they can be effectively used for liquidity purposes in case of need. If an Al has priced its RMLs aggressively without a reasonable spread, this could substantially affect its ability to obtain liquidity quickly by the use of such RMLs should the need arise. The HKMA expects Als to set their mortgage rates with due regard to the long-term average Prime-HIBOR spread (the 390 b.p. mentioned earlier). The rates set should also be sustainable on a long-term basis and provide a reasonable margin after taking into account reasonable operational and administration costs and expected loan losses. In this connection, the HKMA will approach individual Als to understand their pricing strategy. We will also ask them to demonstrate that their current pricing is reasonable and sustainable, and does not expose them to undue reputation, interest rate, or liquidity risk. I would be grateful if you would inform your Members of our concern. I am writing in similar terms to the Chairman of the Deposit-taking Companies Association. Yours sincerely,

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Annex 2 - Residential Mortgage Loans (RMLs)

HONG KONG MONETARY AUTHORITY
香港 金 融 管 理 局 Annex 2
William A. Ryback
Deputy Chief Executive
ERE
Our Ref.: B1/15C
28 February 2005
The Chief Executive
All Authorized Institutions
Dear Sir/Madam,
‘Residential mortgage loans (RMLs)
The Hong Kong Monetary Authority (HKMA) has noticed a growing trend for authorized institutions (Als) to make use of large cash rebates and, more recently, interest/repayment holidays to compete for new residential mortgage business. The HKMA is concerned that the overall risks of such practices to individual Als are not being properly considered and may expose Als to competitive pressures to expand the portfolio of high cash rebate mortgages. I am therefore writing to remind Als of the need to monitor carefully the risks associated with such practices and to set out the treatment of cash rebates and interest/repayment holidays within the context of the 70% loan-to-value ratio guideline (the 70% guideline). Cash rebates made available by Als The HKMA has been discussing with the industry the level of cash rebate’ made available by Als for their RML business. Rebates generally range from 0.5% to 1.5% of the loan amount, but in some cases, rebates of up to 8% or more of the loan amount are made available by individual Als. Borrowers choosing to receive the larger cash rebate, however, are charged a higher mortgage rate for an initial period, generally the first three years. ' A lump sum payment is made in most of the cases but a few Als have chosen to offer cash rebates in the form of interest holidays in which the cash rebate available to the borrower is used to subsidise the mortgage interest payments in the initial period of the RML. 55th Floor, Two International Finance Centre, 香港中 環 金 卅 街 8號國際 金 融 中 心 2 期55 樓 8 Finance Street, Central, Hong Kong 電話: (852) 2878 1688 傳真: (852) 2878 1690 Tel: (852) 2878 1688 Fax: (852) 2878 1690 #0: william _Ryback@hkma.gov.hk E-mail: William_Ryback@hkma.gov.hk 網 班: www. hkma gov.hk Website: www.hkma.gov.hk

The HKMA requires that each Al providing RMLs must have a clear policy on the maximum level of cash rebate to be offered to mortgage borrowers. The level of cash rebate should not be excessive. Cash rebates that are excessive undermine the spirit of the 70% guideline, which prohibits Als from providing finance for the purchase of a residential property in excess of 70% of the value’ of the property. In order to uphold the spirit of the 70% guideline, Als are required to treat the entire amount of the cash rebate as part of the RML amount for the purposes of calculating the loan-to-value (LTV) ratio if the level of cash rebate is in excess of 1% of the loan amount. If the level of a cash rebate is not in excess of 1% of the loan amount, the cash rebate is not required to be counted as part of the RML amount. However, disbursement of the cash rebate should only be made after the completion of the purchase of the property. Cash rebates or interest/repayment holidays subsidised by property developers directly or indirectly The HKMA is also aware of a recent trend where property developers have worked together with individual Als to provide the following special mortgage packages to homebuyers:
(a) in some cases, the developer concerned would pay a sum of money (hereinafter referred to as “cash rebate subsidy”) to an AI for each RML granted to the homebuyers of selected projects. The AI would then include the cash rebate subsidy as part of the cash rebate offered to the homebuyers. The total amount of cash rebate could be as high as 13% to 16% of the loan amount for individual cases; (b) more recently, individual developers have chosen to subsidise, in a lump sum or by instalments, the borrower’s interest payments or principal repayments so that the borrower is offered an interest/repayment holiday by the AL. The holiday period varies from case to case. In our circular dated 20 December 2002, the HKMA made it clear that where a cash rebate or other discount is offered by a property developer to a homebuyer, the discounted price (i.e. after deducting the cash rebate or the discount offered by the developer from the purchase price) should be used as the basis for determining the risk exposure for the purposes of the 70% guideline. Consistent with this requirement, Als are therefore required to use the lower of the discounted price (i.e. the purchase price less the cash rebate subsidy given by the property developer to the 2 The lower of the purchase price or the valuation of the property.

homebuyers directly or indirectly, regardless of whether the subsidy is in a lump sum or by instalments) or the valuation of the property to calculate the LTV ratio for the purposes of the 70% guideline. The HKMA has a further concern that such schemes involving a cash rebate subsidy offered by property developers may undermine the transparency of the transaction. The homebuyers may not be fully aware of the existence of the cash rebate subsidy and the extent to which the purchase price and the cash rebate might have been affected by it. Als should ensure that adequate disclosure has been made to the borrowers in conformity with the spirit and objectives of the Code of Banking Practice (see section 2 of the Code). Credit assessment In line with the HKMA'’s circular dated 28 July 1997, Als must carefully assess the repayment ability of RML borrowers. This is particularly relevant and important for cases where the RML borrowers are known to be seeking additional financing beyond 70% of value from other sources. Als are expected to conduct their credit assessments on these customers carefully and prudently. In particular, they must obtain appropriate income proof from the borrowers and guarantors for assessment. Furthermore, these borrowers should be subject to reasonable test to ensure that they meet the debt servicing ratio (DSR) requirement. The following guiding principles should be observed by Als:
(a) the DSR to be observed by these borrowers should be no higher than 50-60% of income. The upper end of this range should be confined to high income earners only and prudent criteria should be set for borrowers qualified as high income earners; (b) all the known repayment obligations should be taken into account when calculating the DSR. To this end, adequate checks should be performed on the statements of the main bank accounts of the borrowers and guarantors. Moreover, Als should make full use of the information obtained from a consumer credit reference agency to identify other repayment obligations of the borrowers and guarantors, unless there are other acceptable arrangements; (c) the income of other household members should not be taken into account in the DSR test unless such members have provided a formal guarantee or the property is being acquired jointly with those members; (d) in cases where different monthly instalment amounts are payable for different periods of a RML, the highest monthly instalment amount should be used for the DSR calculation; and

(e) where the borrower is offered an interest/repayment holiday, the monthly instalment amount payable after the holiday period should be used for calculation. For the avoidance of doubt, the term cash rebate used in this letter also includes other forms of monetary incentives or benefits (e.g. mortgage interest subsidies or reimbursement/subsidies of the legal fee, stamp duty, or commission for the property agents, etc.) given by Als or property developers to the homebuyers. The requirements of this circular shall take effect immediately but should not affect RMLs already approved. The HKMA will be conducting a round of on-site examinations on the RML business of individual Als. We will assess the institutions’ policy, practices and procedures for observing compliance with the 70% guideline, and the quality of their credit underwriting standards and risk management arrangements for such business. The assessment results will be taken into account when the CAMEL rating of the institution concerned is next reviewed. Yours faithfully, c.c. Chairman, Hong Kong Association of Banks Chairman, DTC Association

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Annex 3 - Prudential Measures For Residential Mortgage Loans

HONG KONG MONETARY AUTHORITY Annex 3
香港 金 融 管 理 局
Our Ref. B4/1C a
蔡 耀 君 JP
23 October 2009
FEL
The Chief Executive
All Authorized Institutions
Dear Sir/Madam,
Prudential measures for residential mortgage loans Further to my letter of 17 September 2009 to the two industry Associations reminding authorized institutions (Als) to be prudent in setting interest rates for residential mortgage by giving due regard to the long-term average Prime-HIBOR spreads, I am writing further to remind Als to ensure that their lending criteria remain sound and prudent in the light of latest market conditions. We note that the prices of luxury properties have risen rapidly in the last few weeks. In particular, prices of Class E properties (size 160 sq. m or above) have already exceeded their peak in the third quarter of 1997 and the risks of lending to this market segment have increased significantly. In view of this, the HKMA considers that it would be prudent and justified for Als to adopt a more conservative loan-to-value (LTV) ratio for this segment of the property market. We are aware that some institutions have already tightened their LTV ratios for more expensive properties. With immediate effect therefore, Als are required to reduce the maximum LTV ratio for properties with a value of HK$20 million or more to 60%. Properties with a value below $20 million will continue to be subject to a maximum loan to value ratio of 70%. However, to avoid the anomaly that the maximum amount which the purchaser of a property with a value of just below $20 million could borrow would be higher than that for a property at $20 million’, the 70% LTV ratio for properties valued below $20 million should be subject to a cap of $12 million. 1 For example the purchaser of a property valued at $19 million could borrow $13.3 million ($19 million x 70%), while the purchaser of a property valued at $21 million would only be able to borrow $12.6 million ($21 million x 60%). 55th Floor, Two International Finance Centre, 香港 中 環 金 融 街8號 國 際 金 融 中 心 2 期55 樓 8 Finance Street, Central, Hong Kong 電話: (852) 2878 8128 傳真: (852) 2878 8130 Tel: (852) 2878 8128 Fax: (852) 2878 8130 電郵: ykchoi@nkma.gov.hk E-mail: ykchoi@hkma.gov.hk 網 址: www.hkma.gov.hk Website: www.hkma.gov.hk 電訊 號 碼; 74776 XFUND HX Telex: 74776 XFUND HX

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Although the 60% LTV ratio referred to in this letter will apply with immediate effect, to avoid causing hardship to borrowers who have already signed a provisional sales and purchase agreement on or before 23 October 2009, a transitional period of one month from that date is allowed for these borrowers to apply for a mortgage based on the existing 70% LTV ratio. With regard to residential mortgage lending generally, Als should, as always, adopt sound lending practices by giving adequate consideration to the borrower’s repayment ability, and ensuring that the debt servicing ratio (DSR) and property valuation are computed prudently. When computing the borrower’s DSR, Als should assess carefully the potential impact on the borrower’s repayment ability if the current unusually low interest rates were to return to a more normal level. Als should maintain proper records of such impact assessment to facilitate monitoring by their internal audit and the HKMA in its onsite examinations. The HKMA has recently completed a round of thematic examinations on Als asset quality, covering residential mortgages. We will be writing to institutions separately setting out our findings and relevant best practices that should be followed by Als. The HKMA intends to conduct another round of onsite examinations in the near future to check compliance with the requirements set out in this letter and ensure that Als have put in place appropriate measures to follow the best practices identified in the thematic examinations. Yours faithfully,