Challenges and solutions for retail mortgage portfolios

Joshua Wander

Estimating losses for mortgage loans is challenging even during periods of economic and regulatory stability. The product set itself is among the most diverse of retail loan asset classes: loan sizes can span from less than US$75K to more than US$750K, loan terms range from five years to 40 years, interest rates can be fixed, variable or time-dependent, and though balances most often fully amortise over the life of the loan, other times they do not. Loan balances could be guaranteed in full or part. The collateral supporting the loan could vary by type, size, value or geographic location. The relatively long lives of mortgage loans mean borrower behaviour and collateral values are likely impacted by the interest rate environment, and by both credit and business cycles.

Already one of the most heavily regulated product sets, Accounting Standards Codification (ASC) topic 326: “Financial Instruments — Credit Loss” (ie, CECL) introduced an array of new requirements and complexity to the way financial institutions (FIs) must forecast their allowance for mortgage loan credit losses. Section 20-30-3 of the CECL methodology states: “an entity may use discounted cashflow methods, loss