If adequate housing is viewed as one of the most basic human rights, why are prices more stretched than ever? Many young borrowers and first-time buyers on low to medium incomes struggle to get on the property ladder, and finding affordable rentals in major cities around the world is becoming more difficult. What role are financial markets playing to help reduce the inequalities? Who might benefit from social mortgages? And importantly, how will social lending affect credit ratings?
S&P Global Ratings believes there are potential credit risks inherent to social lending. This article explains our view and addresses the aforementioned questions.
Frequently Asked Questions
What are social residential mortgage-backed security (RMBS) loans?
Although there is no globally uniform definition of what constitutes a social mortgage, some recent U.K. RMBS transactions and the lender's associated social bond issuance framework were structured to comply with the International Capital Market Association's Social Bond Principles (ICMA's SBP). It defines a social bond as those that use the proceeds exclusively to finance or re-finance new or existing eligible social projects, among other considerations. For social RMBS, the eligible social projects typically include a commitment by the lender to use the proceeds to promote access to affordable mortgage funding and greater financial wellbeing to borrowers, including those who are currently underserved by other lenders.
Social lending typically focuses on providing alternative mortgage solutions to borrowers unable to access financing. This includes borrowers who failed to pass certain credit scoring, require manual underwriting because of complex income, or have not been able to save enough (see chart 1).
It is important to note that the term "underserved" is not specifically defined, raising concerns on the legitimacy of the social responsibility motives of the RMBS issuance in question (i.e. social washing).
How does underwriting differ for social mortgages?
The target population for social mortgages generally falls outside the scope of the more prescriptive lending criteria used by larger banks. As such, the one-size-fits-all approach for underwriting, commonly employed by larger banks to manage large origination volumes, doesn't suit these borrowers. Underwriting typically follows a more manual process that considers the unique circumstances of each borrower. At the same time, we haven't observed a structural shift in underwriting; lenders have yet to materially change the approval criteria or deviate from the servicing procedures used historically. We therefore believe that the recent emergence of social RMBS may not immediately or meaningfully expand the availability of credit to underserved borrowers. That said, in the long term, this could improve if a lower cost of funds for lenders yields more favorable financing terms for these borrowers. Demand and supply dynamics will also play a role in social lending. Although major banks may use alternative cheaper sources to fund their prime originations, RMBS could be a way to fund social mortgages.
What will happen to the composition of RMBS pools?
Although the underwriting and originators' products may not change initially, the composition of RMBS pools might. For example, products such as second-lien, help-to-buy, and right-to-buy mortgages are often securitized as smaller portions of larger RMBS transactions and with products that capture a social need. In order to issue an RMBS transaction exclusively with products classified as social, lenders may group all social products in one transaction, separate from all securitized originations not considered to have a social angle. This would effectively create two securitization brands for the same lender, as well as alter the transactions' risk profile relative to past transactions.
Would social mortgages drive product and RMBS innovation in the longer term?
Whether product innovation is driven by social RMBS or vice versa is similar to the popular chicken-and-egg paradox. A number of products that are likely to be considered social are driven by external factors. For example, retirement-interest only (RIO) emerged from a regulatory shift in the U.K., and parental guarantor mortgages stemmed from pitfalls in the housing markets for first-time buyers. However, in the longer term, the rise of social RMBS, particularly if there is tangible pricing advantage, may create the conditions needed to mainstream the currently niche products.
Are social RMBS deals "social" for the life of the transactions?
The somewhat ambiguous definition of social mortgage and social RMBS opens the door for various interpretations. What's more, as the mortgage and housing markets evolve, investors' view on the social classification may also change within a transaction's lifecycle. Take for example the evolution of the sub-prime market in Europe since its start in the late 1990s. This was initially considered a credit repair product that helped borrowers with slightly blemished credit records obtain mortgage finance. When borrowers had demonstrated a clean payment history for a period, they could refinance to a mainstream lender at a lower rate. However, such loans were--and frequently still are--originated with initial discounts to the borrower that step up after two to five years. The non-discounted rates are often deliberately set high to incentivize prepayment/refinance by the borrower. If regulation or risk appetite changes, or house prices fall (as they did after the 2008-2009 global financial crisis), then borrowers may be left with no viable refinancing option and faced with an interest rate payment that is difficult to reconcile with the concept of social lending, regardless of the good intentions at the onset. Considerations of this nature are important for the evolution of the social mortgage market. During a loan's lifespan, a volte-face in the market consensus of a transaction's social classification could impact secondary market demand.
How do social aspects affect S&P Global Ratings' view of credit risk of these mortgages?
Adding a social label to a transaction has no impact on our approach for sizing foreclosure frequency and loss severity for each loan in our credit rating analysis. Although social RMBS aims to address gaps in housing equality for disadvantaged borrowers, the intention does not necessarily correlate with strong creditworthiness. In fact, we believe there may be elevated credit risks for borrowers in the target populations for social mortgages. We capture these risks by incorporating loan level adjustments for certain mortgage characteristics, as per our RMBS criteria.
|The Pros And Cons Of Social RMBS|
|Credit Quality Impact||Social Considerations|
|Lower savings and down payments, and a limited credit history.||Products such as high LTV mortgages and help-to-buy/ equity loans facilitate house ownership among younger borrowers.|
|Seemingly more exposed than employed borrowers to income instability in a downturn.||Typically complex incomes often require manual underwriting to be properly served.|
|Equity loans and help-to-buy schemes|
|Higher LTV may reduce the borrower's refinancing opportunities in a downturn, and borrowers' see a jump in debt when the loan becomes interest bearing after an interest-free period.||Help-to-buy schemes are designed to bridge the gap between younger borrowers and standard down payments. Equity loans allow homebuyers to have a smaller mortgage without a large deposit.|
|"Remortgagers" just out of arrears|
|Potentially higher default risk based on the very recent adverse credit history, and the more unique mortgage products usually have limited refinancing opportunities.||Some lenders may design mortgage products for underserved borrowers that may have a positive social impact, but the more exotic a mortgage product, the fewer the refinancing opportunities, potentially leaving borrowers trapped in expensive mortgages.|
|Adverse credit history|
|Negative past performance can signal a repeat offense.||Lenders that provide mortgage funding to borrowers with tainted credit records are helping them rebuild their credit profile.|
|High loan-to-value (LTV) ratio|
|The LTV of a loan is a dominant factor in predicting future mortgage performance. Higher LTVs (%) attract higher frequency of foreclosure.||The larger-than-usual loan helps those with fewer savings and limited salary incomes raise deposits to make down-payments.|
|Loan-To-Income and Debt-To-Income|
|We typically adjust the foreclosure frequency to those loans with reduced affordability based on income or ability to service the outstanding debt.||The higher interest rates, to compensate lenders for the higher credit risk in social lending, may be detrimental to borrowers as their affordability will be reduced and a higher share of income will service their loans.|
|Equity withdrawals or debt consolidation|
|Cash-outs tend to have higher default risk than loans used for home purchase or a fully re-underwritten refinancing, including debt consolidation products for borrowers under financial distress.||Debt consolidation may help lower the interest and extend the maturity, easing financial stability. Also, potentially less reliance on expensive tools like credit cards.|
|Prepayments may reduce the excess spread available in a RMBS transaction as loans with higher interest rates refinance once the fixed rate period ends. Prepayments will also accelerate the repayment of the rated notes, exposing them to fewer losses depending on whether they are in the capital structure.||May demonstrate the ability of borrowers to refinance with cheaper mortgage lenders.|
|Expose lenders to mortality and real estate risk, and can create some reliance on property sales to collect capitalized interest and principal once the main borrowers pass away.||When competitively priced, enables older borrowers to support their pensions.|
What trends should we look for?
So far, globally, we have seen three RMBS transactions with a social label.
|RMBS Transactions With A Social Label|
|Issuer||Originator||Country||Issuance Date||Deal Size (Mil.)|
|Gemgarto 2021-1 PLC||Kensington Mortgages||U.K.||February 2021||£470|
|Brass No. 10||Yorkshire Building Society||U.K.||March 2021||$300/£1,500|
|Angel Oak Mortgages Trust 2021-1||Angel Oak Originators||U.S.||May 2021||$231|
|Source: S&P Global Ratings, International Capital Markets Association.|
In our view, similar to green RMBS, several different social RMBS models may emerge. These include:
- Securitizations where the collateral comprises social mortgages exclusively;
- Transactions where the collateral is not from the social mortgage target population, but there is a commitment to use the proceeds from the issuance to originate social mortgages over time; or
- Transactions that include a social tranche to fund a portion of the loan portfolio that meets lender-defined social mortgage criteria.
Because the market has only witnessed a limited number of social RMBS transactions, there is still no evidence of lower credit spreads on these deals compared with plain vanilla transactions issued by high-street lenders. It is too soon to say whether lower spreads on these deals are related to stronger demand or depressed RMBS supply.
Editor: Alisha Forbes.
- Green Mortgages And Green RMBS: What Are The Challenges, June 28, 2021
- ESG Industry Report Card: Residential Mortgage-Backed Securities, March 31, 2021
- Sustainable Debt Markets Surge As Social And Transition Financing Take Root, Jan. 27, 2021
- European RMBS Outlook 2021, Jan. 25, 2021
- Future Flooding Represents A Low Risk For U.K. RMBS Ratings, March 19, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Nicolas Cabrera, CFA, Madrid + 34 91 788 7241;|
|Secondary Contacts:||Matthew S Mitchell, CFA, Paris +33 (0)6 17 23 72 88;|
|Alastair Bigley, London + 44 20 7176 3245;|
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