Singapore Home Loan and Car Home: An Anomaly (Something not quite right)

Article contributed by www.PropertyBUYER.com.sg

HOUSING LOAN
Many banks have cut back on home loan lending. Even the lending Loan to valuation ratio has been reduced from 80% to 70% in some cases.

We all know that Free-Hold or 999 lease hold land appreciates over the longer term of 10 years or 20 years cycle. This coincides with the loan tenure of typically 20 to 30 years cycle. In other words, lending money to individuals for property purchases for first homes are actually very safe banking activities as the land or property is used as collateral not only keeps it's value, but appreciates over the longer time horizon.

There are some 270,000 private houses and condominiums in Singapore. Assuming 10% of households are in negative equity, that is 27,000 units.

And assuming that those 27,000 are in negative equity to the tune of 10%. Assume that their loan size is $500,000. 10% of $500,000 is $50,000 per household. Even if we assume all of these households default on their repayment, we are talking about: -

$50,000 x 27,000 units of housing = $1.35 Billion of losses for banks.

100% CAR LOANS
Since a few years ago, we have seen MAS relaxing rules on banks for Car loan lending. Banks started to lend out 100% for car loans.

Almost everyone knows that except in rare circumstances, most cars are depreciating assets.

If a car of $110,000 price has a scrap value of $10,000. In Singapore cars have a life span of 10 years. This means the depreciation is $10,000 a year. But we all know that cars have steeper depreciation in the earlier years.

So let's say: -

Year 1 - Depreciation = $15,000
Year 2 - Depreciation = $15,000
Year 3 - Depreciation = $13,000
Year 4 - Depreciation = $12,000
Year 5 - Depreciation = $10,000

By the end of each year, the car is worth: -

year 1 - Value of car = $110,000 - $15,000 = $95,000
year 2 - Value of car = $80,000
Year 3 - Value of car = $67,000
Year 4 - Value of car = $55,000
Year 5 - Value of car = $45,000

Assuming that the car's values fall linearly and assuming that the car owner pays up linearly over the course of the 10 years. I.e. $110,000/10 = $11,000 of repayment every year in principle.

Year 1 - Amount owed = $110,000 - $11,000 = $99,000
Year 2 - Amount owed = $99,000 - $11,000 = $88,000
Year 3 - Amount owed = $88,000 - $11,000 = $77,000
Year 4 - Amount owed = $77,000 - $11,000 = $66,000
Year 5 - Amount owed = $66,000 - $11,000 = $55,000

What this means is that, in the case of default (i.e. person stops paying for his installment), in Year 1, bank is owed $99k while car is worth $95k.

Negative Equity in Car loan
Year 1 - Amount owed - Value of car = $99,000 - $95,000 = $4,000
year 2 = $88,000 - $80,000 = $8,000
year 3 = $77,000 - $67,000 = $10,000
Year 4 = $66,000 - $55,000 = $11,000
Year 5 = $55,000 - $45,000 = $10,000

What this means is, the bank stands to lose $4,000 to $11,000 in each of these car loans if the loans are not recoverable from the car owner.

There were some 3,000 COEs (Certificates of entitlement per month) therefore about 30,000 cars sold each year, imagine if 50% of these cars sold were through 100% loans.

And Imagine if 20% of these people default on their loans.

That is 15,000 cars x 20% = 3,000 car loans in trouble. Let's assume the average car loan size $50,000, that is $150,000,000 (of 150million of problem for the banks). Since 100% car loan financing has been around for roughly 3 years. A rough estimate of that would be $0.5 Billion of problems which will hit the bank's bottom line.

WHY HOME LOAN is 90% Maximum (Most banks lend only 80% now) and Car Loan is 100%


Car loans is a small magnitude problem of $0.5 billion of potential losses versus that of housing loan of $1.35 billion of potential losses. Both are easily absorbed by the banks which are operationally profitable.

However, we do feel that Car loans is another problem that will blow up should the economy head further south.

It is a small magnitude problem comparatively with car loans no doubt, but still I do not see the logic of such risk taking behaviour by the banks by giving 100% car loans.

If banks are going to lend 100% for cars in which their collateral is suspect, why not lend 90%, 95% or 100% for Houses?

Nevermind short term house price volatility, because on a longer term, property value tends to go up. Banks will tend to have better Collateral that backs the money they lent out.

Now you see where this logic goes?

Banks charter is to make money.

Banks executives are compensated on profitability of banks, not on risk management.
(No one will pad the CEO on the shoulder for having the safest rating, but making just a bit of money)

Banks, like all organizations are run by people. If there are no rules, human behaviour dictates that banks may take excessive risks just like any organizations would, when they are allowed to do so in order to achieve a reward for meeting objectives or avoid NOT meeting objectives and getting fired or demoted.

This calls for a back-to-basic ground rule and a return to some kind of a keynesian economics whereby some regulatory control are essential.

Milton Friedman's Free Market only works within a certain range, at the extreme end of tight credit squeeze or excessive credit, Free market mechanism breaks down and industries are permanently damaged and do not bounce back in years leading to massive unemployment.

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