HSBC 2006 Annual Report Download - page 192

HSBC HOLDINGS PLC
Report of the Directors: The Management of Risk (continued)
Credit risk > Exposure > Areas of special interest / Cross-border distribution
190
1 HSBC Finance includes lending in Canada and the UK and excludes loans transferred to HSBC USA Inc.
2 Total mortgage lending includes residential mortgages and second lien mortgage lending included within ‘Other personal lending’.
3 Loan to value ratios are generally based on values at origination date.
Mortgage lending in the US
(Unaudited)
Mortgage lending in the US includes loans and
advances to customers with a first lien interest over
a property. These balances are secured and are
reported within residential mortgages. Loans with
only a second lien are reported in other personal
lending. The commentary that follows discusses both
residential mortgages and second lien loans included
within other personal lending.
HSBC continues to monitor a range of trends
affecting the US mortgage lending industry. Housing
markets in a large part of the US have been affected
by a general slowing in the rate of appreciation in
property values, or an actual decline in some
markets, while the period of time properties remain
unsold has increased. In addition, the ability of some
borrowers to service their adjustable-rate mortgages
(‘ARM’s) has been compromised as interest rates
have risen, increasing the amounts payable on their
loans as prices reset higher under their contracts. The
effect of interest rate adjustments on first mortgages
are also estimated to have had a direct impact on
borrowers’ ability to repay any additional second
lien mortgages taken out on the same properties.
Similarly, as interest-only mortgages leave the
interest-only payment period, rising payment
obligations are expected to strain the ability of
borrowers to make the increased payments. Studies
published in the US, and HSBC’s own experience,
indicate that mortgages originated throughout the
industry in 2005 and 2006 are performing worse than
loans originated in prior periods.
The effects of these recent trends have been
concentrated in the mortgage services business
(‘mortgage services’), which purchases first and
second lien mortgages from a network of over
220 third party lenders. As detailed in the
table below, this business has approximately
US$49.5 billion of loans and advances to personal
customers, 10.4 per cent of the Group’s gross loans
and advances to personal customers.
In 2005 and continuing into the first six months
of 2006, second lien mortgage loans in mortgage
services increased significantly as a percentage of
total loans acquired compared with prior periods.
During the second quarter of 2006 HSBC began to
experience deterioration in the credit performance of
mortgages acquired in 2005 by mortgage services in
the second lien and portions of the first lien
portfolios. The deterioration continued in the third
quarter of 2006 and began to affect second and first
lien loans acquired in that year. Further deterioration
in the fourth quarter of 2006 was largely in the first
lien adjustable-rate and second lien portfolios.
HSBC also determined that a significant number of
its second lien customers have underlying
adjustable-rate first mortgages that face repricing in
the near-term which, based on experience, are
estimated to adversely affect the probability of
repayment on the related second lien mortgage. As
numerous interest rate rises have occurred as credit
has tightened and there has been either a slowdown
in the rate of appreciation of properties or a decline
in their value, it is estimated that the probability of
default on adjustable-rate first mortgages subject to
repricing, and on any second lien mortgage loans
that are subordinate to adjustable-rate first liens, is
greater than has been experienced in the past. As a
result, loan impairment charges relating to the
mortgage services portfolio have increased
significantly.
Accordingly, while overall credit performance,
as measured by delinquency and write-off rates, has
performed broadly in line with industry trends across
other parts of the US mortgage portfolio, higher
delinquency and losses have been reported in
mortgage services, largely in the aforementioned
loans originated in 2005 and 2006. A number of
steps have been taken to mitigate risk in the affected
parts of the portfolio. These include enhanced
segmentation and analytics to identify the higher risk
portions of the portfolio, and increased collections
capacity. HSBC is restructuring or modifying loans
in accordance with defined policies if it believes that
customers will continue to pay the restructured or
modified loan. Also, customers who have adjustable-
rate mortgage loans nearing the first reset, and who
are expected to be the most affected by a rate
adjustment, are being contacted in order to assess
their ability to make the higher payment and, as
appropriate, refinance or modify their loans.
Furthermore, HSBC has slowed growth in this
portion of the portfolio by implementing repricing
initiatives in selected segments of the originated
loans and tightening underwriting criteria, especially
for second lien, stated income (low documentation)
and other higher risk segments. These actions,
combined with normal attrition, resulted in a net
reduction in loans and advances in mortgage services
during the second half of 2006. It is expected that
this portfolio will remain under pressure as the loans
originated in 2005 and 2006 season. It is also
expected that this portfolio will run off faster than in