Securitisation and the Danish mortgage credit system

WPFS WORKSHOP ON SECURITISATION

Madrid, 27-28 May 2010

Maria Jose Alvarez Pelaez

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We will talk about

• Securitisation: Definition(s) – why the interest to compile statistic?

• Characteristics of the Danish mortgage credit system (DMCS)

• Discussion: Should the DMCS be considered as securitisation for statistics purposes?

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Securitisation – OECD ”work” definition

1. Process whereby an institutional unit raises funds by issuing securities and

2. enabling the investors investing in these securities to buy directly parcels of specific financial assets

3. Securities are issued to fund assets and the cash flow of the underlying assets represents the interest claims of the securities issued

4. Increasing complexity with the emergence of financial intermediaries: special purpose entities (SPEs)

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Securitisation- SNA93 11.75

• New negotiable securities are often issued backed by existing assets such as loans, mortgages, credit card debt, or other assets.

• This repackaging of assets is often referred to as securitisation.

• The creation of the new assets gives rise to entries in the financial account.

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Securitisation

• It has been driven by different considerations– For non financial corporations: cheaper

funding cost than available through banking facilities

– For financial institutions: a) getting around the regulatory

capital requirementsb) risk transferc) diversification of funding

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Interest for compiling statistics

• Do the SPEs have a different risk profile?

• Do the SPEs have high leverage?• Securitisation makes the financial

system more unstable?• Implies maturity mismatch?• Increasing complexity of the loan

process: long intermediation chain

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Interest for compiling statistics

• Impact on analysis of financial flows and securities markets

• It hampers correct analysis of the growth in credit extended by credit institutions within the framework

– of financial regulation policy (less transparency)

– of monetary policy (as an activity indicator)

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The Danish mortgage model

• More than 200 years of Danish mortgage lending:

• It emerged after the Great Fire of Copenhagen in 1795, when a number of wealthy persons took the initiative to establish the first mortgage association, that granted loans based on the issuance of bonds .

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The Danish mortgage model

• Mortgage institutions grant loans secured by mortgages on real property, having only one source of funding: bond sales.

• Statutory loan-to-value limit: the loan can not excess 80% of the value of the property at the time of the sale. The mortgage institution has priority.

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DMCS: properties

• Mortgage institutions do not retain repayment risk due to regulation: the “balance principle”:– It restricts mortgage institutions

opportunities to take interest rate, exchange rate, liquidity and option risk limits the institutes’ ability to assume risk other than credit risks.

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DMCS: properties

• The balance principle requires that mortgage banks fund their lending activities by issuing mortgage bonds with cash flows that fully match those of the underlying mortgage loans:

matching funding principle

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DMCS: properties

match funding principle ensures:– transparent loan costs (interest + principal

payments + margin charged by mortgage banks). Bonds listed on a stock exchange

– Market-based prices (current financial market trends)

– Attractive prepayment options (by buying the underlying bonds in the market at a price of 100 (par) or below

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DMCS: properties

• Innovations in mortgage loans will be reflected on the funding side.

• Investors who buy the issued bonds do not incur any default risk in practice (almost all bonds are Aaa rated). It is a secure product that has never led to credit losses.

• It has a stabilizing effect on the Danish economy and helps sustain financial stability.

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DMCS: properties

• Many advantages for borrowers:– interest rates are attractive (legal framework

and credit policy of mortgage institutions make loans very secure)

– Everybody can monitor loan prices on a current basis

– Borrowers may prepay their loans on attractive terms

– Mortgage institutions cannot call loans prematurely

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DMCD and financial stability

• The Danish mortgage bond market is one of the largest in the world (absolute and relative to size of the economy)

– nominal outstanding amount of Danish mortgage bonds of EUR 300 bn, 72% of the total Danish bond market and approximately 1.4 times Denmark’s GDP

• It is more than four times larger than the Danish government bond market

• The DMCS has survived all economic downturns thanks to a strong foundation

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DMCS and financial stability

• This foundation has contributed to stabilizing the Danish economy– Mortgage lending continues during

crises (Figure 1)

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300

350

400

450

500

550

600

650

1.100

1.200

1.300

1.400

1.500

1.600

1.700

1.800

Bank lending to NFI Bank lending to households

DM lending to NFI DM lending to households (right)

Bn DKK Bn DKK

2005 2006 2007 2008 2009

Figure 1. Bank and mortgage lending to households and NFI

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DMCS and financial stability

• Homeowners may benefit from falling interest rates: with fixed rate loans, there is protection against housing price declines:– housing prices drop when interest rates

increases, which implies a drop in bond prices.

– As mortgage debt is linked to bond prices, it will decrease

– Fixed rate loans are about 35% of stock (Figure 2)

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0

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70

Adjustable rate within a year Interest only loansAdjustable rate loans Floating rate loans with interest rate cap

Pct.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Figure 2. Mortgage lending to households

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Securitization – OECD ”work” definition

1. Process whereby an institutional unit raises funds by issuing securities and (TRUE)

2. enabling the investors investing in these securities to buy directly parcels of specific financial assets (TRUE)

3. Securities are issued to fund assets and where the cash flow of the underlying assets represents the interest claims of the securities issued (TRUE)

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DMCS as securitisation

• The system reflects securitisation process characteristics, but– historical characteristics: not part of

the recent development of the securitisation process

– Very short intermediation process– There are not special purpose entities

(SPEs) in the system

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DMCS as securitisation

– Mortgage institutions take the risk if payments of the mortgage are not realized

– No getting around the regulatory capital requirements

– No risk transfer– From ECB point of view is not securitisation

since statistical information is included in monetary financial institutions (MFI) statistics

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DMCS as securitisation: it depends…

… on statistical targets:

- If the aim is capture new information on securitisation: getting around capital requirements, long intermediation chain and so on DMCS should not be considered as securitisation- If the aim is statistics on asset-backed securities (comparison between countries) DMCS should be considered as securitisation