ISSUE OF NEGATIVE EQUITY DURING PROPERTY DOWN CYCLE: A COUNTERFACTUAL ANALYSIS

Abstract

The issue of negative equity during periods of sharp declines in real estate values poses a systematic risk for mortgagee banks as well as of concern for policy makers. Concerns are aggravated when banks adopt valuations based on transaction prices, in which the buffer against negative equity depends substantially on the mortgage origination loan-to-value ratios. This study examines how a policy change requiring an independent valuation to be obtained before transaction takes place affects the collateral risk for mortgagee banks. A counterfactual approach will be adopted covering private residential real estate transactions in Singapore from 1995 to 2010, tracing the change in values over several property market cycles, spanning the Asian Financial Crisis and the Global Financial Crisis. X-Value, an Automated Valuation Model (AVM) designed by SRX, will serve as a convenient proxy for independent valuation in this study. Mortgage portfolios would also be marked-to-market using various approaches, such as broad market price index and AVM, to monitor how collateral values would change over periods of price declines. The policy implications would be relevant for MAS and banks. Results have shown mixed evidence of adopting independent valuation prior to transaction as the basis of collateral valuation provides a larger buffer against negative equity in a rising market. Marking-to-market of mortgage loan portfolios using AVM as compared to URA PPI for re-estimating the change in property price is also found to lead to lower negative equity incidences. Various market segments are observed to perform differently when collateral valuation is based on AVM.