Mortgage & Consumer CreditMedium

What the seat actually does

This seat lends to households: a mortgage secured on a property, or unsecured credit against an income. It is the largest lending book most banks have, and the one with the longest memory — a loan written this year is still on the balance sheet in twenty.

Two numbers decide almost everything. How much of the property's value is being lent against it, and how much of the borrower's income the payment takes. The first decides what the bank recovers if it goes wrong; the second decides how likely that is.

• Underwriting — the policy, the model, and the cases that sit outside both.
• Pricing — fixed for a period or floating, and what the bank pays to fund either. See fixed against floating.
• Servicing — collecting the payment, handling the change of circumstances, and the arrears process when there is one.
• Distribution — what the bank keeps and what it packages and sells. See mortgage-backed securities.

A day, and where it goes

• The pipeline — applications in progress, and what is holding each one up.
• Pricing. What the bank's own funding costs today and therefore what a new fixed rate can be. See treasury and ALM.
• Arrears. Who missed a payment, for how long, and what the rules require to be offered before anything else.
• Redemptions. Borrowers repaying early, which is a prepayment for the bank and a re-pricing for the customer.

What it is measured on

• Volume and margin — how much was written and at what spread over the bank's own funding.
• Arrears and losses, which arrive years after the decision that caused them.
• Prepayment, because a book that repays faster than expected earns less than it was priced to earn.
• Whether the model still predicts. A credit model fitted through a benign decade has not been tested on the one that matters.

What it touches on this site

• What the book becomes — MBS, CMBS and the mechanism behind them, securitisation.
• The interest rate risk — swaps, and why a fixed rate has to be hedged rather than simply offered.
• When it goes wrong — 2008, where the security was the assumption that failed.
• The plain version — why a bond falls when rates rise, which is the same arithmetic as a fixed-rate book.

How it goes wrong

• The security and the borrower fail together. House prices fall for the same reasons incomes do, so the recovery is worst exactly when it is needed.
• Affordability tested at today's rate. A payment that fits at one rate and not at another is a decision that was never made.
• Growth by loosening. The fastest way to write more volume is to accept files that were previously declined.
• Distribution removing the incentive to care. A loan sold on the day it is written is a loan whose losses belong to somebody else.

Concepts to master

• Loan-to-value and affordability answer different questions — how much is lost if it defaults, and how likely default is.
• A fixed rate is an option the borrower holds: they can repay early when rates fall and will not when they rise.
• Duration applies to a loan book exactly as it does to a bond. See the yield curve.
• Credit spreads price the same question from the other side — see credit spreads.