Households, Intermediaries and Originators in Mortgage Markets ERES Annual Meeting 2012, Edinburgh Ruben H.G.M. Cox Rotterdam School of Management, Erasmus University

Mortgage lending

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

Descriptive statistics (2)

Specification of regression 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

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

Results (3): Results by originator for insured mortgages Involvement intermediary increases household LTV-ratio by 6-7 percent

Results (4): Results by originator for uninsured mortgages 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.

Literature (1) Banks face substantial competition in consumer credit markets (De Haan and Sterken, 2011; Claessens and Laeven, 2005; Toolsema, 2002) Profitability of mortgage origination is under pressure because of new entrants and interest rate competition (World Retail Banking Report, 2009). Survey research among banks executives shows that the marketing and sales productivity (57% of respondents) is a key opportunity to cope with these challenges while reducing origination and distribution costs (World Retail Banking Report, 2009/2011) Involvement of intermediaries can assist in achieving this objective: sales expenses are contingent on actual sales made (commissions) for originators.

Literature (2) The nature of compensation of FI’s creates a potential conflict of interest with that of borrowers: –Recommend products that are most profitable to them (Berndt et al., 2010; Hassink and Van Leuvensteijn, 2007) This problem is further exacerbated in a competitive market where agents are simultaneously responsible for searching new customers and selling products (Inderst and Ottaviani, 2009): –Incentive to indiscriminately sale a product following the search effort –Lowering of standards/potential for misselling So why would originators accept these risks? –Let the good times roll: stable/rising house prices disguised potential risks (Demyanyk and Van Hemert, 2008) –Securitization /insurance (Keys et al., 2010, Avery et al., 2006)