SECURITISATION: RESIDENTIAL MORTGAGES 9 September 2009 AUHF - - PowerPoint PPT Presentation

SECURITISATION: RESIDENTIAL MORTGAGES

9 September 2009 AUHF

2

BACKGROUND INFORMATION

■ World wealth $44 trillion of which:

■ 50% property (residential, agricultural, C&I) ■ 30% residential properties ■ Bonds 27% ■ Equities 19% ■ Cash 3%

■ Fundamental premise:

■ Widespread property ownership is a desirable goal of every society Thomas Jefferson: “The small landowners are the most precious part of a state (1785)” ■ This is achieved by an effective and economically efficient link between residential mortgages and the long term financial markets ■ Widespread home ownership cannot be achieved without a robust financial system

■ Fundamentally there are two Archetypes of long term financial markets:

■ Banks and bonds: ■ Banks originate loans, hold them on their books and fund them through: ■ Issuing long term deposits or bonds (attract funds through over collateralization e.g 125%) ■ General liabilities of a bank ■ Government support can be in the form of a guarantee on the bonds e.g. liquidity facility

3

BACKGROUND INFORMATION (CONTINUED)

■ SPVs and Securitisation ■ Bank sets up a SPV and sells loans into this (off balance sheet) ■ Bank sets up senior/subordinated structure (bank part), with bond market buying the senior part ■ Government support could guarantee a portion of the senior part, thus capping bond holder losses. ■ Similarities in both structures: ■ Government at back of queue and its role protects against systemic risk or promotes the credibility of the SPV ■ Added advantage of securitization is that it guarantees the investors access to the mortgages where on balance sheet collateralization might not ■ Institution that originates and manages the loans takes on the initial credit risk and passes on the interest rate risk to bond market investors ■ No need to guarantee individual loans ■ Risk controlled by capital and stress tests ■ Which structure to choose: ■ Depends on regulatory and tax issues. ■ Banks and bonds favored in emerging economies as it is less likely to require new laws, banks are best at managing credit risk and so can manage the principle/agent problem better (past 20 years has seen the unbundling of the 4 major aspects of mortgage lending:

• rigination, servicing, funding and credit risk but this has created principle/agent

problems)

4

BACKGROUND INFORMATION (CONTINUED)

■ Outcomes ■ Improved efficiencies ■ Require strong legal and regulatory framework as secondary market exposed to risks which the primary market doesn’t have ■ Secondary market merely a vehicle for allocating capital ■ Depository based systems can do the same thing as secondary markets do (connect mortgage borrowers with people with money) without having to sell mortgages, but require stable interest rates ■ Guarantees can cause “moral hazard” (excessive risk taking, leading to poor capital allocation and taxpayer bailouts) ■ First best economic solution ■ Proper legal system “if you want people to have good housing, you have to be able to take it away from them” ■ Property rights ■ Good disclosure ■ Good information ■ Competitive markets ■ Second best economic solution ■ Asymmetric information ■ Poor disclosure ■ Poor foreclosure laws (justification for Government providing support – guarantees, long term funding support)

5

BACHGROUND INFORMATION (CONTINUED)

■ Secondary market funding ■ Securitisation (package into pools), Debt or combination thereof ■ Standardisation promotes Government agencies e.g. Fannie Mae ■ Pass through security – payment from pool to investors (Ginnie Mae) ■ Market evolved to include private market pools, derivative securities (CMOs with up to 50 payment tranches, with a pool of 30 year callable securities being broken up into short, medium, long term bonds), futures, hedges against interest/prepayment risk, mortgage insurers etc ■ Unbundling takes advantage of scale economics, division of labor, promotes competition between suppliers of the various bundles BUT it comes at a cost: ■ Each player that focus on one part of the bundle is dependent upon the other players performing their role ■ Principal/agent problems ■ Transparency/moral hazard ■ Understanding of risk by investors (removed/complex) ?

• Important Lessons
• It is the function rather than institutional mechanism of connecting mortgage and

capital markets that is important (several models available)

• The “front end” creates a good mortgage market (proper registration, foreclosure and

eviction procedures ) as opposed the “back end” - doing deals/getting mortgages off balance sheet etc

• Controlling soundness and safety requires serious consideration of risk based capital

(stress based tests, regular audits, risk based standards etc)

• Don’t take interest rate risk
• Conflict between GSEs and demands for social housing
• Diversification and insurance
• LTVs and area/borrower demographics

6

SHAPING THE FUTURE ■ Opening up securitization again/Shaping the Future

■ Regulation (Basel 2, consumer protection and information disclosure) ■ Technology (distribution channels) ■ Principal/agent and moral hazard ■ Simplicity ■ Investor liquidity ■ Housing as an wealth creator (long term investor confidence) ■ Economic recovery ? ■ Consumer demand ■ US, China vulnerability ■ Our next engine of growth ? ■ US to move its focus from “stealing their future generations money” to getting the market to open up again ■ US Fed to convince investors to move away from MBSs ? ■ Recent SA experiences ■ In ICU (mortgages no longer sexy – quality, capital intensive, margins, property illiquid asset) ■ Investor liquidity an issue ■ SA Home Loans ■ Standard bank ■ Absa By its very nature property is a bubble commodity – it has and will continue to boom and bust. The trick is to get the cycles right.

7

SHAPING THE FUTURE (CONTINUED)

■ Limited direct effects ■ Insignificant exposure to sub-prime ■ Limited use of structured finance ■ Markets remain “prime” (smaller, more conservative) ■ Intensified indirect effects ■ Slow down in growth (affects demand) ■ Return of inflation ■ Liquidity squeeze and market distrust (increase cost of funds) ■ Credit contraction ■ Additional credit risks (variable/adjustable rate loans) ■ Higher energy/food costs ■ Bank decapititalization ■ Foreign banks withdraw/downsize from Africa ■ Depressed capital markets ■ Africa perceived as potential “sub prime” market by investors

8

HOUSING FINANCE IN AFRICA (CONTINUED)

■ Steady demand (urbanization) ■ Access to finance remains a policy priority ■ Continuance of undeveloped mortgage markets ■ Easy expansion over for many countries ■ Vulnerable countries: liquidity, high LTV variable loans, weak lending standards etc ■ Liquidity crisis: securitization, roll-over refinancing ■ Cost of funds to increase ■ Diversity tools: covered bonds, liquidity facilities ■ Non-bank lenders require secure access to bond markets ■ State support: liquidity, systemic risk, sunset clauses

9

CHALLENGES FOR AFRICA

■ Improve land and housing policy (supply constraints) ■ Build market infrastructure (title, foreclosure, appraisal etc) ■ Smart subsidies (not linked to bailout packages) ■ Support for rental market (not just ownership) ■ Improve ways to finance low/informal income households (risk sharing tools, housing microfinance, savings schemes etc) ■ Diversify domestic funding models ■ Tighter securitization framework (lenders first loss, simplistic/transparent models, legal/regulatory framework) ■ Lethargic markets (how to deepen penetration and sound lending) ■ Risk based pricing, capital retention in property cycles ■ Improve borrower education ■ Information (data) improvement ■ Limit/identify property bubbles

10

Alternative Model

■ Investors

• Want to commit capital to long term uses
• Fixed return
• Diversified portfolios
• Safety which mortgages offer
• Borrowers
• Certainty which fixed rates offer
• Availability of full amortisation tarm
• Various refinancing options
• Financial Institutions
• Balance risk/profit
• Whilst deposit base can fund a substantive portion of mortgage assets, there is a need

for this to be supplemented by access to the bond market:

• Liquidity backup and funding alternatives
• Long term fixed rate liabilities often not available in deposit markets
• Ability to hedge the options embedded in mortgage contracts
• Home Loan Bank Model/Mortgage Liquidity facilities (premise: assets of high

quality)

• Home Loan Bank pools the mortgage loan portfolios of numerous banks
• Provides large scale financing to banks
• Issues simple, classical debentures with short to long term maturities at favorable

interest rates (AAA/Aaa)

• Banks get attractive rates
• Mortgages are pledged as collateral with wide collateral margins
• May contain prepayment options
• Promotes greater competition

11

ALTERNATIVE MODEL (CONTINUED)

■ Promotes product standardization/transparency ■ Lenders adhere to best practice ■ Increases market information systems which in turn promotes better risk management ■ Deepens the financial market ■ Can be effectively used to promote delivery of policy objectives e.g. affordable housing ■ Must adhere to market based pricing (market distortion issue) ■ Don’t need critical mass and can issue debentures anytime

(NB: It must stay away from regulation and politics and focus on banking)

■ Creating a model ■ Step 1: Create primary market mortgages ■ Step 2: Bond market (the base market of traded securities) ■ Step 3: Link private credit institutions to the bond market through the Home Loan Bank

• rganization model
• Becomes more sophisticated over time as market develops and can co-exist with other

market instruments – could even be viewed as an in-between leading up to a full secondary market

• Successful models Cagamas (Malaysia), France, Jordan, Algeria,West Africa ?
• Preconditions
• Effective mortgage legislation, including repossession upon default
• Fixed income market
• Credit bureau
• Efficient mortgage/land registration systems
• Efficient judiciary
• Appraisers
• Functional securities market