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FitchRatings-London-09 October 2014: Limits on high loan-to-value (LTV) and loan-to-income (LTI) lending proposed by the Central Bank of Ireland would in the long term reduce credit risk in the Irish residential mortgage market through more prudent lending Fitch Ratings says.

The central bank's study showing significantly higher default rates for loans with high LTV and LTI is in line with our findings. Both ratios are major factors in our analysis of Irish RMBS and covered bonds.

The central bank's consultation paper published 7 October proposes limiting how much banks can lend to individuals with LTVs above 80% and LTIs above 3.5 to 15% and 20% of new lending respectively and limiting buy-to-let lending with LTV greater than 70% to 10% of new lending.

We believe LTV at origination is a key driver of a borrower's willingness to repay mortgages and is positively correlated with foreclosure frequency. LTI affects borrowers' ability to pay another key driver of foreclosure frequency.

Restraining high LTV and LTI lending should reduce mortgage foreclosure frequencies over time as outlined in our rating criteria for Irish RMBS and covered bonds.

LTV and LTI (or debt-to-income DTI) are not the only drivers of defaults. We use DTI to account for borrower debt and interest rate stresses.

We also stress the foreclosure frequency of mortgages with less standard characteristics and adjust assumptions for lenders with riskier underwriting practices. The introduction of a credit register in 2016 will provide lenders with a comprehensive assessment of the borrower's ability to pay.

Our criteria increase the probability of default for higher-LTV loans. In our base case 'Bsf' rating scenario for a standard loan we assume a 6.1% foreclosure frequency for loans with an origination LTV of 75%-80% and a DTI of 30%-40%. Increasing the origination LTV to 80%-85% while leaving DTI unchanged raises the foreclosure frequency assumption to 7.2%. Raising the LTI to 40%-50% further increases the foreclosure frequency assumption to 7.8%.

A regression analysis on about 54000 loans with a mix of vintages shows that for LTVs above 80% the foreclosure frequency increase associated with higher LTVs becomes greater when DTIs are higher too.

A LTI cap could therefore be important for the Irish market where there has been a sharp decline in the proportion of new mortgage loans with LTVs of over 90% since 2010 but an increase in 80%-90% lending.

The central bank says 44% of new lending by volume for primary dwelling purchase in 2013 was at LTVs above 80% and 23% at LTIs greater than 3.5x.

Lending volumes are around 10% of pre-crisis volumes but mortgage approvals have increased in 2014 on 2013 and the rise in prices in Dublin may be a factor in the higher proportion of lending at 80%-90% LTVs.

Lending volumes could fall in the short term while borrowers adjust to the limits especially first-time buyers who are most likely to borrow at higher LTV and LTI ratios.

High LTV lending is more risky when property prices are above sustainable levels. In some jurisdictions including the US and UK we have introduced a Sustainable Home Price model into our analysis to take account of prices growing faster than fundamental econometric factors would suggest

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Publication:Cambodian Business Review
Date:Nov 30, 2014

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