In view of the steady increase in investor inquiries regarding Hong Kong's residential mortgage-backed securities (RMBS) market, S&P Global Ratings is providing a market overview to address some common queries.

1. Hong Kong Housing Market Overview From An RMBS Perspective

1.1. Overview of Hong Kong's land scarcity

Hong Kong has a total land area of 1,117 square kilometers and a population of around 7.3 million. However, only 7% of all land in Hong Kong has been developed for residential use. 75% of overall land has not been built up and includes woodland, and grasslands, among others (see chart 1).

1.2. Property type

High-rise apartments predominate in Hong Kong's mass residential markets 

High-rise apartments are the most prevalent form of housing in Hong Kong's mass residential markets, owing to high density and scarcity of land. The residential market in Hong Kong is classified by apartment size based on government statistics, and is characterized as either "mass", "large", or "luxury" units (table 1).

Table 1

Private versus public housing units 

As of Sept. 30, 2022, there were about 3 million housing units in Hong Kong, of which private and public housing accounted for about 56% and 44% respectively.

Public rental housing (PRH) and subsidized home ownership scheme (HOS) or subsidized sale flats (SSF) target low-income households with certain income limits and net asset limits (see chart 3).

PRH and SSF accommodate about 46% of the population in Hong Kong. SSF are sold at discounted prices to eligible buyers, and are generally subject to selling and leasing restrictions.

The Hong Kong government is designating 70% of new housing supply for public housing over 2022-2032. We believe the increase in public housing supply is likely to have a limited impact on private residential home prices, due to the restrictions on eligibility for rental, purchase, and resale of the public housing units, as well as well-supported mass market demand.

1.3. Housing price trend

We believe downturns in Hong Kong's residential property prices are mostly correlated with the city's economic weakness (see "Hong Kong Property Companies Have More Breathing Room", published March 28, 2023). With a fall in real GDP by 3.5% last year, private residential home prices fell by about 16% in 2022, the first annual drop since 2003.

In 2022, market sentiment was dampened by heightened local stock market volatility, growing concerns over U.S. policy rate hikes, the spread of the omicron variant of COVID-19, and tightened social distancing measures locally.

Having said that, we believe Hong Kong's home prices will rise by 5%-8% in 2023 on an improving economic outlook following the removal of COVID-19 restrictions. Supported by solid pent-up demand, transaction volume for primary residential property will likely increase to 15,000-17,000 units in 2023, from 10,315 units in 2022. However, we believe developers will price their projects conservatively in 2023 amid high inventory, a supply spike in 2024, and elevated rising interest rates.

Economic downturns and housing price in the past three decades 

Hong Kong experienced a few economic downturns and property cycles, which indicate property price trajectory under economic stress. Chart 3 shows past economic downturns in Hong Kong, and property price declines throughout the associated periods. Table 2 summarizes key macroeconomic indicators and property price index movement during each economic downturn.

Table 2

Factors likely driving housing prices 

Many factors drive property prices. We illustrate two notable ones that are unique for Hong Kong compared with other markets. We believe persistence or evolution of these factors may offer some clues to future housing price trajectory.

• Imbalanced supply and demand: On average, there were about 53,000 married couples registering annually from 2005-2019. However, the annual supply of private and public housing units was less than 29,000, creating a shortfall of over 360,000 units for the whole period. The limited supply of new private homes and solid mass-market demand contributed to the continual increase in the property prices over the years. The demand for public housing, as indicated by the number of applicants on the PRH waiting list, also moves largely in tandem with the property price trend (see chart 4).

• Stringent macroprudential policies may lead to less activity in secondary market. Given the persistent increase in house prices, the government introduced three types of stamp duties to deter housing market speculation and curb rising house prices (see table 3).

Table 3

The imposition of SSD for sellers of residential property within the first three years of purchase has been particularly effective in discouraging speculative activities.

The introduction of SSD hit the turnover in the secondary market. Monthly turnovers reached 2000-5000 units in the past decade, compared with 6,000-13,000 transactions before the SSD was introduced (see chart 5). The decline in turnover drove prices higher, to a certain extent.

1.4. Ownership

Low home ownership ratio 

The home ownership ratio in Hong Kong was about 50% on average in the past five years. This is relatively lower than most advanced economies, such as the U.S. and Europe (generally above 60%). In Asian economies like Singapore and Taiwan, the ratio is as high as 90% and 85%, respectively (see chart 6).

The low ownership ratio in Hong Kong could be a result of low housing affordability, which could be attributable in part to consistently low home supply in the past.

According to Hong Kong Monetary Authority (HKMA), despite the fall in property prices in 2022, housing affordability remained stretched. The housing price-to-income ratio stayed at a high level of 18.8 years in the second quarter of 2022, compared with the previous peak of 14.6 years in 1997. The income-gearing ratio also remained high at 87.9%, well above the long-term average of 60%. The higher the ratios, the lower the housing affordability.

Legal ownership: Hong Kong has a leasehold system 

The main law governing real estate in Hong Kong is the Conveyancing and Property Ordinance (CPO), which is adapted from English law. The legal system in Hong Kong is the common law system, which is set to remain in force until at least 2047.

In Hong Kong, virtually all land is leasehold, except a piece of land for one cathedral. Land rights are provided under government lease, which conveys certain rights to occupy, develop, and use parcels of land in the territory in return for payment of government rent. The terms of government lease are mostly either 75 years or 99 years, and in exceptional cases, 999 years on the Hong Kong Island and Kowloon. This leasehold system was established in 1843, and stayed broadly unchanged after the handover to China. Since July 1997, key policies of the government involving land leases include:

• New leases of land shall be granted for a term of 50 years from the date of grant (except new special purpose leases for other various purposes such as recreation) at premium, and subject to payment from the date of grant of an annual rent equivalent to 3% of the rateable value of the property at that date, adjusted in step with any changes in the rateable value thereafter; and
• Non-renewable leases (i.e. those fixed-term leases containing no right of renewal), may upon expiry, be extended for a term of 50 years without payment of an additional premium but subject to an annual rent equivalent to 3% of the rateable value of the property.

According to Hong Kong's Lands Department, over 30,000 land leases in the New Territories and New Kowloon will expire before June 30, 2047. There are also some old leases of lots on Hong Kong Island and in the Kowloon Peninsula that will expire before 2047 and contain no right of renewal.

The government has stated that 2047 is not a "time limit." This was in response to public concerns over the uncertainty in land tenure and the implications for property transferability and mortgage financing in the medium to the longer term. The government added that "it has clear and definite policy for handling matters related to the extension of land leases upon expiry, and it will make arrangements to deal with the lease extension work at an appropriate juncture."

In October 2016, HKMA also made a public statement to assure banks that they were not required to adjust their mortgage lending policies, because the government had the power to extend the leases expiring in 2047.

2. Mortgage Market

2.1. Mortgage originators and mortgage insurance

There are three types of mortgages providers in Hong Kong: banks, property developers and other finance companies. The majority share of outstanding mortgage loans in Hong Kong is originated by the "Authorized Institutions," which are subject to the supervision of HKMA, Hong Kong's de facto central bank. This categorization covers banks and some finance companies that take deposits.

Hong Kong's mortgage market is dominated by the three largest players: Bank Of China (Hong Kong) Ltd., The Hongkong and Shanghai Banking Corp. Ltd. (HSBC), and Hang Seng Bank. The three banks typically account for at least 60% of the number of mortgage applications every month (for both completed and incomplete properties).

Developers' mortgage loans are usually provided via co-financing schemes as part of their marketing strategy. Under these schemes, a bank will lend up to 60% of the property price to first-time homebuyers, and the developers, through their subsidiaries or related finance companies, will provide additional mortgage loans on the remaining 40% of the purchase price.

Other finance companies may provide mortgage loans to mortgagors who cannot meet the underwriting requirements of the banks. These finance companies may also be able to provide more customized mortgage loans, such as loans with property ages that are older than the ones commonly accepted by banks, or mortgage loans for more than 60% of the property value. These finance companies can also provide second mortgage loans, which require the consent of the first mortgage provider.

As of Dec. 31, 2022, the total amount of mortgages outstanding for authorized institutions was about HK$1.8 trillion, according to HKMA's monthly survey. At the same time, about HK$23.2 billion of the outstanding mortgages, equivalent to 1.3% of the total outstanding, were associated with co-financing schemes involving the provision of top-up finance by property developers or other finance companies.

Over the past 10 years, private residential mortgage loans accounted for about 25% of total loans disbursed by all authorized institutions (see chart 7).

While there is very limited data on the outstanding mortgage loans provided by developers and other finance companies, the value of such loans accounted for only a very small portion of the total outstanding mortgages in 2016 and 2017, based on a press release from Hong Kong's legislative council in 2018.

According to the IMF's 2022 country report on Hong Kong, HKMA scrutinized nonbank mortgage lending, which has declined in recent years amid tightened regulations and the expansion of the mortgage insurance program (MIP) offered by the Hong Kong Mortgage Corp. (HKMC).

Table 4

HKMC, the primary mortgage insurance provider in Hong Kong, saw a surge in loans drawn down under its MIP since 2020 after the Hong Kong government relaxed the ceiling on the mortgage financing scheme in late 2019. This in turn meant an increase in the cap on the value of properties under the MIP. Mortgage loans drawn down under the MIP increased nearly threefold to HK$98.3 billion in 2020 from HK$33.3 billion in 2019. As of end-2022, mortgage loans drawn down under the MIP totaled HK$107.2 billion.

HKMC also acts as a liquidity provider by acquiring residential mortgage loans from banks in times of need, such as in 2008 when Hong Kong experienced liquidity and credit shortages as a result of the global financial crisis. The amount that HKMC purchases each year depends on the prevailing liquidity conditions. HKMC began offering fixed-rate mortgages in November 2021 as an alternative financing option to homebuyers. As of end-2021, HKMC's residential mortgage portfolio amounted to HK$3.6 billion (versus HK$4.1 billion in 2020).

The mortgage insurance market is dominated by the HKMC. QBE Mortgage Insurance (Asia) Ltd. (QBE) and AIG are the two other companies that also offer mortgage insurance in Hong Kong.

2.2. Market concerns regarding high household debt-to-GDP in Hong Kong

In recent years, a rise in Hong Kong's household debt-to-GDP ratio has led to concerns about financial stability. The ratio increased to 93% in 2021 from about 68% in 2016. However, in S&P Global Ratings' view, risk from household debt is limited in Hong Kong because more than two-thirds of such debt is made up of residential mortgages; credit card advances only account for about 5% of household debt. Hong Kong households' high savings rate and financial assets should also provide substantial cushion in case of any stress (see chart 8, and "Banking Industry Country Risk Assessment: Hong Kong" published August 22, 2022).

Another supportive factor is the low proportion of homeowners that have properties with mortgages (34% of overall homeowners had mortgages in 2021). In other words, two-thirds of the homeowners are mortgage-free (see chart 9).

2.3. Mortgage loan features

Most mortgages in Hong Kong have the following features:

• Fully amortizing.
• Maximum loan to value (LTV) ratio: not exceeding certain thresholds, based on property value, loan purpose, income source, and usage of MIP. See section 2.5 for further details. During the past five to six years, LTV of new approved loans was 45%-60% (see chart 10).

• Size of mortgage: We estimate the average size of Hong Kong's outstanding mortgages at about HK$3.1 million as of end-2022. The average size of new mortgages has been increasing since the loosening of the loan cap in late-2019 (see chart 11). Average value of new mortgages was about HK$5 million in 2022, a sizable increase from around HK$4.2 million in 2019.

• Debt servicing ratio (DSR): The borrower is subject to DSR and stressed DSR tests. See section 2.5 for further details.
• Term to maturity: Usually five to 30 years, with 30 years being the tenor ceiling allowed by HKMA.

• Majority are floating rate, priced in either of the following:

1. HIBOR-based mortgage plan: Interest rate of the Hong Kong Interbank Offered Rate (HIBOR) plus a certain percentage point, or the interest rate cap under the plan (if any), whichever is lower;

2. Prime-based/best lending rates (BLRs) mortgage plan: interest rate being the prime rate of the relevant bank (typically 5.625%-5.875% as of January 2023) minus a certain percentage point.

As of December 2022, 67.5% of new mortgage loans were benchmarked against HIBOR, and about 26% of the loans are BLR-based. Fixed-rate plans account for an immaterial share in the mortgage loan market (see chart 12).

• The most common repayment method is equal instalments. Other types of repayment plans include:

1. Interest-only period followed by equal instalment: A mortgagor can make repayment instalments that cover the interest only, but not the principal payment, for part of the repayment period. This is normally the initial two or three years, followed by equal instalments for the remaining term of the mortgage.

2. Progressive repayment plan: The amount of repayment instalments accelerates periodically, for example, annually, to speed up repayment of the whole loan, thereby saving the total amount of interest payable.

3. Flexible prepayment and redrawal plan: This plan gives the mortgagor the option to make prepayments of a certain minimum amount during the repayment period, in addition to regular instalments, to shorten the loan tenor. If mortgagor needs cash at any time during the repayment tenor, they can request an amount, usually not exceeding the amount prepaid, to be redrawn and to form part of the mortgage loan. The remaining tenor of the loan would be lengthened as a result.

4. Fortnightly repayment plan

• The mortgagor charges/mortgages the property to the bank as security.
• Home insurance is typically required for mortgage application.
• Prepayment penalty: a percentage (usually 1%-2% of the loan amount) during the first two to three years since the drawdown date for early redemption or prepayment of the loan. A flat fee may apply to prepayment after the first two to three years.

2.4. Regulatory dynamics

Regulator: HKMA  HKMA, the de facto central bank of Hong Kong, is the primary regulator of the Hong Kong banking sector. HKMA's chief objective is to strengthen risk management and ensure the long-term stability of the banking sector. To this end, HKMA implemented eight rounds of tightening macroprudential policies between 2009 and 2017. These policies included lowering the limit on LTV and DSR ratios, increased risk-weight floor on new mortgages, as well as tightening requirements for banks' due diligence and underwriting processes.

Since the implementation of these measures, the average LTV and DSR ratios of new residential mortgages have been consistently below 60% and 40%, respectively.

2.5. Underwriting criteria

When banks are underwriting a mortgage loan, some of the key considerations include:

Borrowers' ability to repay:  The borrowers' monthly income, which includes salary, commission or profits, and other sources of regular income such as rental income. Banks may also use credit reports from a credit reference agency (e.g. TransUnion) as a reference to assess the mortgage application.

Borrowers' income source:  Whether a borrower's income is regular (salaried employee) or irregular (self-employed/business owner).

Borrowers' relationship with banks:  The borrowers' banking relationship and previous account activities.

Full documentation:   All institutions must have a clearly defined and documented policy to assess the repayment capability of residential mortgage borrowers, which include the use of a DSR test. Income proof can include: tax demand note, bank statements showing salary income, employment contract or salary slips. Other required documents include Hong Kong identity card, (provisional) sales and purchase agreement, tenancy agreement for investment property, and may also include an assignment of interest in the rental income of the property by the mortgagor to the bank as additional security.

Limits on loan-to-value (LTV) ratio:  HKMA has set guidelines on the LTV ratios of residential mortgage loans for banks to follow (see table 5 and 6).

Table 5

Table 6

Limits on DSR:  HKMA also specifies limits on the debt servicing ratio (DSR) of each residential mortgage to assess the repayment capability of borrower. The DSR is defined as the monthly repayment obligations of the borrower as a percentage of monthly income.

In addition to DSR limit, HKMA also requires borrowers' stressed DSR limit (assuming a 200-basis point interest rate increase) to be below 60%.

Table 7

Limit on loan tenor:  Maximum loan tenor for all new property mortgage loans and car park mortgage loans should not exceed 30 years and 15 years, respectively.

Other lending criteria that banks may consider:

Sum of property age and loan tenor:  Usually not exceeding 40 years or 50 years; some banks may require the age of the property not exceeding a certain limit, e.g. 30 years.

Sum of age of borrower and loan tenor:  Some banks may set a certain limit, such as 65 years, as the maximum sum of the age of the borrower and the loan tenor.

Property appraisal:  In case of a discrepancy between the valuation from the bank and the property sales price, the bank may not approve the full amount of mortgage applied for.

3. Hong Kong's RMBS Market

3.1. Long history, but limited issuance and participants

The Hong Kong RMBS market was established in 1994. The market became more active between the late 1990s and 2007, before the global financial crisis. The HKMC issued more than HK$10 billion of mortgage-backed securities (MBS) during 1999-2006, accounting for around a quarter of the total issuance in Hong Kong's securitization market for that period. Other non-bank financial institutions (NBFIs) also tapped the RMBS market in the 2000s. In our view, the legacy transactions have little implications for today's market because all major aspects of the local RMBS sector have evolved significantly.

Since the global financial crisis, Hong Kong's RMBS market has remained quiet, with limited issuance. Most of the issuances since then were related to NBFIs and took place in the private domain. That said, we believe some market participants are likely to tap investors via public placement during the next two to three years.

3.2. Key potential issuers

NBFIs and money lenders are key potential issuers of RMBS in Hong Kong.

Some NBFIs and money lenders have business needs to offload their mortgage assets occasionally due to limited funding channels available to them, compared with commercial banks and deposit-taking companies.

Besides, the HKMC strives to promote the development of the MBS market in Hong Kong. HKMC views such securities as an effective instrument to channel long-term funding from the debt market to supplement the demand for long-term financing generated by mortgage loans.

3.3. Key risks from a rating perspective

Building concentration:  Given that high-rise apartments predominate Hong Kong's residential property market, it is not uncommon that the development has a single or twin tower, and the units of the building are mortgaged to one or a few mortgage providers. Where it happens, we may take additional considerations to address the heightened risk associated with building concentration.

Basis risk:  Potential basis risk could arise in various scenarios in the RMBS sector. In Hong Kong, majority of mortgage loans are currently priced at HIBOR plus a positive spread, or subject to an interest rate cap with reference to prime rate or BLR minus a spread. Other mortgage plans are priced at a negative spread over different prime rates, as adopted by the originators.

If the underlying mortgage pool is priced with reference to BLR, while the notes pay a spread over HIBOR, this would give rise to basis risk. The transaction would be susceptible to an upward HIBOR environment when the adjustments in BLR do not match those in HIBOR. We may consider the potential mismatch in our cash flow analysis, and apply our "Methodology To Derive Stressed Interest Rates In Structured Finance" criteria, published April 8, 2022 for the interest rate stress. Such a test may affect the credit enhancement level of the notes.

However, different originators may adopt different BLR, which are adjusted by the originators per se, following adjustments to the base rate by HKMA that track the interest rate shifts by the U.S. Federal Reserve (see chart 13). The lack of a standardized BLR could be a challenge in forming our view on the basis risk, particularly when a non-major bank originator adopts its own BLR, which is not widely used in Hong Kong.

Moreover, the one-month HIBOR quoted by mortgage banks could be different among bank originators, depending on the bank's cost of borrowing per se in the interbank market. HSBC and Hang Seng Bank tend to offer a slightly lower HIBOR than the HIBOR rate quoted by the Hong Kong Association of Banks. The difference could lead to an interest rate mismatch between the HIBOR used in the underlying mortgage loans and the notes (see chart 14). Although the interest rate mismatch may be minimal, we may apply certain stress to address the potential for basis risk if the HIBOR associated with the underlying mortgage loans is lower than that of the notes.

Small pool size:  Originators that do not have a sizable mortgage loan book may securitize a small pool of assets, e.g. less than 250 loans. In our view, smaller pools (which are defined as less than 250 loans in our "Global Methodology And Assumptions: Assessing Pools Of Residential Loans" published on Jan. 26, 2019) exhibit greater idiosyncratic behavior than large and highly diversified pools. Therefore, for RMBS pools with less than 250 loans at the time of the initial bond issuance, we apply an adjustment factor to the foreclosure frequency.

Second-lien mortgage:  Money lenders that are not under the supervision of HKMA may offer second-lien mortgages with original LTV higher than the 60% cap. The repayment method may also be different from the typical monthly principal and interest payments, and could instead comprise interest-only and balloon repayments. In our view, mortgage loans with atypical characteristics that deviate from local market features are considered to pose higher risk. We may apply a higher adjustment multiple to the foreclosure frequency for an individual loan or pool with different credit attributes than the archetype.

3.4. Legal and regulatory regime

Common law system:  Hong Kong operates on a common law system historically based on English law. The Basic Law provides that the common law system shall be maintained for at least 50 years from the date of the handover on July 1, 1997. Unlike civil law jurisdictions such as Korea, Japan, and Taiwan, there is no specific securitization legislation in Hong Kong.

Transaction structure:  Special purpose vehicles (SPV) are typically used in securitization transactions in Hong Kong. The SPV will beneficially own the assets purchased from the originator and issue notes to investors. They are generally orphan entities established in tax haven jurisdictions such as the Cayman Islands or Bermuda that are bankruptcy-remote such that the SPV's assets will not be commingled with the originator's.

While the transaction documents usually impose restrictions on the business activities and indebtedness that the SPV can undertake and incur, a legal true-sale opinion is usually required from a rating perspective.

Asset transfer:  Receivables can be transferred and effected by way of a legal or an equitable assignment. Where an assignment is not disclosed by notice to the debtor, as commonly seen in securitization, the transfer will take effect as an equitable assignment via a sale-and-purchase agreement between the originator and the SPV. The originator will retain the legal interest in the assigned receivables until the occurrence of a title perfection event, which requires the originator to serve a notice of assignment to the relevant obligors to perfect the assignment as a legal assignment.

In an equitable assignment, a debtor may have rights of set-off or counterclaim against the originator, which would be binding against the SPV. The originator and the obligor may also amend the terms and conditions of the receivables without consent from the SPV. We would therefore require representations and warranties by the originator not to undertake any such activities.

Tax:  The SPV could be subject to profit tax in Hong Kong if the government deems it to be engaged in trade or business in Hong Kong. The profit tax can usually be minimized when the entity's profit matches its allowable deductions.

Stamp duty is payable on the transfer of interests in land. Mortgage transfers are generally not subject to stamp duty. There is no capital gain tax and withholding tax on interest payments, nor value-added tax in Hong Kong.

Regulatory requirement:  Authorized institutions intending to conduct any securitization transaction in Hong Kong should inform the HKMA in advance and will need to comply with the relevant guidelines.

3.5. Asset performance

Stable and low default rates 

The performance of residential mortgage loans (RML) underwritten by authorized institutions in Hong Kong has been resilient to economic downturns, with a historical delinquency ratio that has never exceeded 1.45%. According to HKMA, the 90-day plus delinquency ratio stayed low at 0.06% as of end-2022. HKMA credits this to banks' prudent underwriting standards under the authority's supervision of the mortgage lending sector.

Key performance drivers 

Mortgage delinquencies tend to be positively correlated with high unemployment rates and high interest rates, and negatively correlated with rising property prices and tight macroprudential policies such as LTV regulations.

Based on publicly available information, the 90-day plus delinquency ratio surged to less than 1.2% following the Asian financial crisis, when the one-month HIBOR jumped to more than 19% in August 1998. Property prices had declined by 45% between 1997 and 1998.

The delinquency ratio peaked at 1.43% in April 2001 during the dot-com bubble in 2000 and 2002 when the Hong Kong stock market fell by almost 50% from the peak, and then moved in tandem with the interest rate between 2001 and 2004.

The deemed default ratio, which includes loans overdue for more than three months as well as rescheduled loans, peaked at 1.65% in mid-2003. This was during the Severe Acute Respiratory Syndrome (SARS) outbreak, when the unemployment rate hiked to a historic high of 8.8%, and moved in tandem with the unemployment rate during 2001-2008 (see chart 15).

Despite the surge in the deemed default ratio during the SARS outbreak, delinquency rates on mortgages remained low in Hong Kong, partly because interest rates had fallen sharply since 1997, and partly because the territory's middle-class mortgage borrowers remained employed mostly, despite higher unemployment rates in the wider economy. The vast majority of mortgage borrowers are middle class and their continued employment enabled them to service their mortgages (see "Hong Kong Bank Mortgages Up 19% Over Five Years Despite Falling Prices", published May 23, 2003).

The delinquency and deemed default ratio continued to decline since June 2003 and showed low sensitivity to volatilities in interest rate and the surge in unemployment rate during the global financial crisis in 2008-2009 and the COVID-19 pandemic in 2020–2022 (see chart 15). According to HKMC, the low delinquency ratio is attributable to the prudent underwriting standards adopted by industry practitioners and the effective regulation and monitoring of the mortgage market by the HKMA.

Besides, the delinquency and default rates are likely to decline when credit growth and asset prices are on the rise. The quality of banks' residential mortgage portfolio was underpinned by rising property values and higher household income since 2004.

Negative equity loans are rising, but remain low at the absolute level 

Negative equity refers to homeowners whose outstanding RML with an authorized institution exceeds the current market value of the mortgaged property, based on the calculations by HKMA. It does not include mortgage loans associated with co-financing schemes which would be in negative equity if the second mortgages were taken into account.

The number of RML in negative equity increased in 2022 because of a decline in property prices. As of end-2022, there were 12,164 cases of mortgage loans in negative equity with an aggregate value of HK$66.3 billion, compared with 21 cases with an aggregate value of about HK$126 million at the end of 2021.

Having said that, the portion of RML in negative equity (as of Dec. 31, 2022) is relatively low, and accounts for 3.66% of total mortgage loans outstanding, compared with a peak of more than 30% during the outbreak of SARS in June 2003 (see chart 16). Also, the recent cases were related to bank staff housing loans or RMLs under MIP, which generally have a higher LTV ratio.

Since the first quarter of 2011, there have been no RML in negative equity with delinquencies of more than three months. According to HKMA, the risks in banks' mortgage business are controllable, because loan quality under the MIP is still very good, with a delinquency ratio of only 0.01%.

Performance of mortgage loans originated by nonbanks is opaque 

No public data related to mortgage loans originated by non-HKMA regulated and money lenders is available.

3.6. Prepayment

In Hong Kong, prepayment of mortgage loans is driven by two main factors:

• Housing turnover: borrowers repaying their mortgage loans upon the sales of the underlying properties; and
• Refinancing: borrowers refinancing their mortgage loans to obtain lower mortgage rates

Prepayment tends to increase in tandem with a buoyant property market and intense mortgage competition with declining interest rates.

The monthly prepayment rate of HKMC's RML portfolio can be used as a reference for the mortgage loans' prepayment rate in Hong Kong. Based on publicly disclosed information and our calculations, the constant prepayment rate (CPR) of HKMC's portfolio was within a range of 10%-20% most of the time over the past two decades. The highest observed CPR was 49.8% in February 2000, and the lowest was 4.7% in March 2022 (see chart 17).

According to HKMA, the high CPR from the second half of 1999 to the first half of 2000 was driven by increasing refinancing activities triggered by the aggressive cutting of mortgage rates by banks. We believe the low CPR in March 2022 was probably caused by the temporarily closure of retail banking operation owing to the spread of the omicron variant of COVID-19, and tightened social distancing measures, as well as the sluggish property market.

3.7. RMBS Issuance Might Appear

We expect more small and medium-sized originators to tap Hong Kong's RMBS market in the next two to three years for balance sheet management and funding, both in the private and public domain.

Meanwhile, we believe that the securitization market in Hong Kong may see more diversified asset types in the next few years, such as infrastructure related securitization.

4. Appendix

4.1 Owner Occupancy

There are about 2.7 million households in Hong Kong, of which around 1.4 million (52.6%) are owner-occupiers.

4.2 Population Distribution

We summarize population distribution in table 8. Thresholds for defining concentration are typically based on a market's population distribution as a proxy for diversification. For example, a threshold of two times the population is typically used under our criteria "Global Methodology And Assumptions: Assessing Pools Of Residential Loans", published Jan. 26, 2019, rounded as necessary.

The criteria address geographic concentration risks in a pool by applying adjustment factors to the foreclosure frequency for portfolio concentrations that exceed specific geographic thresholds (e.g. regions and/or counties). Geographic concentration risk emanates from the risk of a localized downturn in a given country.

Table 8

Related Criteria

• Methodology To Derive Stressed Interest Rates In Structured Finance, Dec. 8, 2022
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 26, 2019

Related Research

• Hong Kong Property Companies Have More Breathing Room, March 28, 2023
• Hong Kong Property: A Year Of Cyclical Pain In 2023, Oct. 30, 2022
• Banking Industry Country Risk Assessment: Hong Kong, Aug. 22, 2022
• Hong Kong's Tight Property Supply Becomes An Advantage, Nov. 23, 2020
• Hong Kong Bank Mortgages Up 19% Over Five Years Despite Falling Prices, May 27, 2003