Households, Intermediaries and Originators in

Mortgage Markets

ERES Annual Meeting 2012, Edinburgh

Ruben H.G.M. CoxRotterdam School of Management, Erasmus University

Mortgage lending

Mortgage production (€/year) € 0 - € 2.5 million € 2.5 - € 5 million € 5 - € 10 million

Bonus 0% 0.20% 0.25%

Traditional mortgage products

Linear mortgage 0.75% 0.95% 1.00%

Alternative mortgage products

Savings mortgage 2.50% 2.50% 2.50%Endowment mortgage 2.25% 2.45% 2.50%Life-insurance mortgage 2.25% 2.45% 2.50%

The compensation structure of intermediaries

Source: Ecorys, 2004

Research idea

• Why would a lender employ differential underwriting criteria for direct written and brokered mortgages?

• If lender has risk (and reputational) exposure, then it has screening incentives; – E.g. non-insured mortgages

• If risk is transferred (securitized or insured), then screening incentives might be weakened (Keys et al., 2010; Avery et al., 2006);– E.g. insured mortgages

• So brokers can only work within the acceptability criteria of the lender if lenders have risk exposure.

Measuring the outcome of underwriting process

• Driven by data availability;

• Need a proxy for a ‘suitability’-standard (Inderst and Ottaviani, 2009)

• Loan-to-value ratio:– Measure of indebtedness of household– Proxy for loss-given-default for originator/insurer

• Debt-service-ratio:– Measure of affordability for household– Proxy for probability of default for originator/insurer

Hypotheses

Hypothesis 1

Intermediaries have an insignificant effect on LTV and DSR ratios if the mortgage is uninsured.

Hypothesis 2

Intermediaries possibly have a positive effect on LTV and DSR for insured mortgages.

Dataset

• Data are from the DNB Household Survey (DHS):– Survey yearly administered among a representative sample of

2000 Dutch households;– The survey started in 1993;– Wide coverage of topics: work, wealth, income, housing, health,

psychological concepts.

• Origination channel is administered since 2002– Only first mortgages originated after 2001 are included in the

sample.

• Excesses based on underwriting standards published by NIBUD (Institute for Budget Education) and National Mortgage Guarantee (NHG).

Descriptive statistics (1)

Source: DNB Household Survey

Mean N Mean N Mean NLoan-to-value ratio

Intermediated 98.5% 131 87.4% 115 100.0% 424Direct written 91.8% 84 87.7% 98 88.0% 318

Debt-service ratio

Intermediated 28.0% 109 28.4% 97 22.4% 549Direct written 23.7% 70 25.6% 83 18.4% 395

Non-eligibleEligible/not-insuredInsured

Variables Mean Std. Dev. N Mean Std. Dev NInterest rate 4.7% 0.01 660 4.6% 0.01 1025 2.76***Fixed rate period (1 = yes) 88.8% 0.32 741 90.3% 0.30 1151 -1.02NHG-insured (1 = yes) 28.6% 0.45 742 36.8% 0.48 1153 -3.70***Log(propertyvalue) 4.87 0.68 737 4.85 0.63 1144 0.68Log (household income) 10.50 0.43 742 10.40 0.46 1152 4.44***Log (amount of mortgage) 4.86 0.66 589 5.01 0.53 865 -4.60***

Direct written Intermediated T-stat for mean diff.

Descriptive statistics (2)

Specification of regression model

• General OLS-model:

• Ratioi is either LTV or DSR ratio for household i

• Main variable of interest is dIntermediary

• Control variables in X:– Mortgage characteristics (fixed rate dummy, interest rate,

mortgage guarantee)– Household characteristics (composition, education, income,

value collateral, wealth, gender, marital status etc.)

• ‘Excess’ analysis is based on a logit-model

Results (1): Full sample

Mortgage controls: fixed rate-period, interest rate, mortgage-guarantee, mortgage type

Demographic controls: household composition, education, income, value collateral, wealth, gender, marital status, retired

(1) (2) (3) (4)LTV DSR ExcessLTV ExcessDSR

Intermediated (1 = yes) 0.037** 0.000 0.331** -0.235[2.21] [0.02] [2.15] [-1.15]

Controls Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes

N 1333 1521 1333 1521R2-adj/Pseudo R2 0.303 0.509 0.164 0.303Log-Likelihood - - -700.6 -402.0

Results (2): Results by originator

Insignificant results are also found for the logit-analysis (underwriting-excesses)

Mortgage controls: fixed rate-period, interest rate, mortgage-guarantee, mortgage type

Demographic controls: household composition, education, income, value collateral, wealth, gender, marital status, retired

LTV DSR LTV DSRIntermediated (1 = yes) 0.019 0.008 0.045 -0.005

[0.92] [1.10] [0.94] [-0.32]

Controls Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes

N 731 812 602 709R2-adj 0.339 0.493 0.260 0.536

Banks Non-Banks

Results (3): Results by originator for insured mortgages

Full sample Banks Non-Banks Full sample Banks Non-BanksIntermediated (1 = yes) 0.067** 0.060* 0.091 0.014 0.010 0.030

[2.51] [1.93] [1.32] [1.56] [0.85] [1.25]

Controls Yes Yes Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes Yes Yes

N 454 241 213 483 242 241R2-adjusted 0.151 0.154 0.160 0.586 0.604 0.597

Loan-to-value ratio Debt-service-ratio

Involvement intermediary increases household LTV-ratio by 6-7 percent

Results (4): Results by originator for uninsured mortgages

Full sample Banks Non-Banks Full sample Banks Non-BanksIntermediated (1 = yes) 0.026 0.004 0.023 -0.006 0.007 -0.020

[1.15] [0.17] [0.41] [-0.75] [0.73] [-1.02]Controls Yes Yes Yes Yes Yes Yes

Year dummies Yes Yes Yes Yes Yes YesN 879 490 389 1038 570 468R2-adjusted 0.320 0.365 0.298 0.489 0.472 0.528

Loan-to-value ratio Debt-service-ratio

Involvement of broker is insignificant when mortgages are not insured

Economic significance

• Is the monetary incentive large enough for the broker?

• Assume 7 percent increase in debt-level for an insurable savings mortgage;

• If 10 mortgages are 7 percent levered up, say from 250K -> 268K;

• Additional broker income is 5400 euro or 8 percent increase;

• Additional searching- and screening costs are small.

Robustness checks

• We account for endogenous channel selection by households:– IV-model yields similar results

• We check for heterogeneity in risk-preferences, that might influence indebtedness:– No effect was found

• It is examined whether intermediaries have an effect on the pricing of the credit (LaCour-Little, 1999):– No effect was found

Conclusions and implications

• Originator screening incentives and broker monitoring are maintained for uninsured mortgages but appear to weaker for insured mortgages;

• Limited evidence that households are expropriated by brokers;

• Mortgage insurer is the ‘victim’ of the compensation incentives;

• Redesign the insurance contract to a deductibles/coinsurance structure with the lender.