UBS flags reverse mortgage risk as market turns

In a Monday trading update, Bendigo and Adelaide Bank (ASX: BEN) explained that it has changed the treatment of its equity release/reverse mortgage product, Homesafe, for cash earnings purposes to “exclude any unrealised income and/or losses and associated funding costs”. The announcement comes as the bank prepares to report its full-year results on 14 August.

The Homesafe product allows older Australians to sell a stake of their homes in return for an upfront cash payment to help fund their retirement. The bank’s ownership stake in the property then rises over time with a gain or loss made when the home is sold, usually when the customer dies or downsizes.

In a research note titled Ding, Ding, Ding – Has BEN rung the bell on housing?, UBS analyst Jonathan Mott said Bendigo’s accounting change is appropriate, but that the timing is “unusual”.

“BEN has been booking substantial Homesafe mark-to-market gains (and very occasional losses) through its 'Cash Earnings' since 2007. It is only now as Sydney and Melbourne house prices are in bubble territory and house prices have begun to slip in recent weeks that BEN has changed its policy,” he said, noting that it is likely BEN would have booked further mark-to-market gains in 2H17E.

UBS believes the reverse mortgage product is a “risk” to the bank and says that while Homesafe is profitable, it should not sit on Bendigo’s balance sheet.

“Homesafe is extremely lucrative in periods of rapidly rising house prices in Sydney and Melbourne (such as the last three years) but in the event of a fall in house prices or even a prolonged period of flat house prices, is an earnings headwind,” Mr Mott said.

“As a result, we are glad to see BEN is no longer [marking]-to-market these movements through its cash earnings.”

The latest figures from CoreLogic, released last week, showed home values in Sydney and Melbourne fell by 1.3 per cent and 1.7 per cent, respectively, during the month of May.

[Related: Sentiment turns, investors exit as housing comes off the boil]