Subprime. Its notoriety prevails throughout the world. The word alone conjures up vivid memories of recession, ruined investors, and failed banks. With the financial crisis in the United States allegedly over, the question for us begs, does subprime lending exist in Israel? Can history repeat itself here? This question was posed to the Head of Retail Banking at Bank Mizrachi-Tefachot in an interview. His response: “By us (Israel), there is no subprime. “ Is it in fact true that subprime lending doesn’t exist? And even if there is subprime lending, is there any risk for the average homeowner?
So far, so good
Israeli banks are currently enjoying an extremely low level of defaults. Recently, one large bank reported its problematic loans ratio i.e. the loans it expects to have problems collecting, at 0.1% of all outstanding loans. Borrowers across all sectors of credit in Israel have been making their payments on time. Consequently, bank profits have spiked as outstanding credit expanded and the mortgage market swelled to 5 Billion NIS funded in June alone.
The subprime market
In the U.S. and other countries where subprime lending thrived, the market was made up of three basic types of loans. They include loans to borrowers with poor credit histories, loans with limited income or asset documentation and No Doc (no documentation) loans. Approximately 80% of these loans were made based on adjustable rates. False assumptions made by lenders were that housing prices would continue to rise, refinancing would be readily available, and that fraud levels were relatively low. Thus, subprime loans grew to about 20% of the U.S. mortgage market in 2006 or about US $2 Trillion.
Prime “minus” or Sub-Prime?
Israel is infamous for its tight bureaucracy spanning many sectors from Governmental offices to corporations. When it comes to banks, the perception is no different. Tough bankers and strict qualifying criteria are to be expected as the norm in Israel. However, a view from the inside reveals some “unconventional” lending practices. In the race to gain market share in a booming real estate and mortgage market, some Israeli banks have been attempting to gain share even if it means relaxing their underwriting criteria. Non-traditional methods used to calculate income can include bank statements, support letters from family or other institutions. Credit reports for foreigners are not a requirement at some banks and low credit scores and previous defaults are overlooked at others. Loans are overwhelmingly made on adjustable rates at only 0.5%-1% higher rates for riskier borrowers. Additionally, many banks do not factor in total debt, of which other mortgages can be a tremendous factor, in calculating debt-to-income ratios. As a U.S. banker who lived through the subprime heyday and subsequent crash, some of these practices are reminiscent of the U.S. subprime lending model.
Despite the resemblances to the mistakes made in other banking systems around the world, Israel’s system is different. Firstly, the lid on supply combined with healthy demand for housing has kept the Real Estate market aloft amid continuous calls for a meltdown. A fundamentally strong real estate market is one of the best buffers against a rise in defaults as it causes the average homeowner to be very careful in shielding their most prized asset from foreclosure. Secondly, in Israel, a personal guarantee is a made by every borrower on all mortgage loans. In the event of default, the tactics used to retrieve money can go way beyond the property and even include freezing personal assets such as bank accounts. This reflects a sharp contrast to subprime lending in the U.S. where there was no personal guarantee made and the property was the only means of recouping money owed to the bank. Thirdly, LTV (loan-to-value) ratios in Israel are only 50-55% on average and rarely ever go over 70%. This is a huge difference between the overleveraged days of subprime when 95% financing was readily available. That means that even if the real estate market were to drop 20%, “strategic defaults” would not be very strategic as borrower’s equity would not be completely destroyed.
Although there are many factors in play to help mitigate fallout from lax lending standards at Israeli banks, some worries remain. The impact of higher interest rates in a market where 70% of loans being originated are adjustable is concerning. As Stanley Fischer said last week, “Anyone who takes an adjustable now and thinks they will be paying 2% in a few years is mistaken.” However, the factors of personal recourse and low LTV ratios should offset potential losses at the banks.