Transcript Slide 1
Asia Pacific Union for Housing Finance
International Conference on Housing
April 10-13, 2013 New Delhi, India
MORTGAGE COVERED BONDS:
ECONOMICS, BENEFITS, CHALLENGES
Olivier Hassler
[email protected]
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A fast growing market
Outstanding amounts- Chile, Korea not included (millions Euros –
Source: ECBC)
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A clear geographic expansion, but still a mostly European
market - Only 4 countries in Asia currently: Japan, Korea, Russia, Turkey
India, Brazil, Mexico, Morocco: frameworks under way
Source: Euromoney:
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The Benefits of Covered Bonds
For lenders
Long term funding, fixed rates available
But ALM mismatches generally (bullet repayment vs amortizable loans)
Rating enhancement can be significant (several notches possible)
Cost effective, cheaper than securitization
For investors
High level of security , with yield pick up
Market liquidity: no valuation problem, large volumes, market making
achievable under certain conditions, repos
From a macro perspective: financial stability factor
Long term investments stimulated by security conditions
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The 7 Pillars of a CB system
1.
Types of assets
2.
Quality standards
3.
Additional components of the cover pool
4.
Segregation of assets
5.
Coverage mechanism
6.
Supervision
7.
Management of insolvency situations
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Assets
1.
Main types
Traditional: well secured , low risk profile loans
Residential mortgage loans
Secured Commercial real estate loans
Public sector loans
Ship loans, used only Germany and Denmark
Trend towards diversification : consistent with the concept?
Special Commercial real estate CBs (Ireland)
SME loans (Korea, Turkey – Asset Backed Bonds distinct from Mortgage CBs-, draft US
legislation, Germany – recent transactions, but with a public sector guarantee )
2.
Aircraft finance (Germany)
Export finance CBs (Spain)
Consumer loans (draft US legislation)
Quality standards
Basic standards (legal, contractual ) to eliminate risk factors - LTV, valuation: key elements
3.
Other components of the cover pool
Substitute assets, to allow flexibility in the management of the pool : e.g. prepayments, large
issues preceding the extension of new loans
Hedging instruments
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Coverage
4.
Segregation of assets
Objective: avoid mingling the cover pool with the general bankruptcy estate
Methods: depend on the national legal system
5.
Ring-fencing on balance sheet loans (typically recorded in a public register)
Specialized subsidiaries set out by dedicated legislation - ex.: France
Separation issuer /guarantor holding the cover pool: structured CB model, transposed in
legal frameworks of countries where it was prevailing (Austr., NZ, Netherland, UK)
Mechanics
Coverage in terms of
principal balance outstanding (repayment perspective)
Net Present Value (liquidation perspective)
interest cash flows (continuity of servicing the bonds)
Overcollateralization
“structural”: to face temporary mismatches (delinquencies, cash flows gaps)- legal miinimum
“dynamic” : to face changes of situations (e.g. issuer’s downgrade, periodic asset coverage
tests, fall of real estate prices )
Asset coverage tests to check the coverage on an on-going basis
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6 - Supervision
Cover pool monitor
Compliance with requirements, legal checks
Checks of withdrawals from / entries in the cover pool
Verification of calculations (e.g. valuations, tests)
Independently organized function
Supervision by the banking Authority
Licensing
Registration of programs
Special on-going oversight
Market information on cover pool
Initial disclosure
On-going disclosure
Transparency: a new emphasis of statutory & market practices (ECBC
label, CBIC template, some national regulatory frameworks - ex. Norway)
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7 - Management of Insolvency Situations
Ring fencing legally binding
No automatic acceleration of maturity: central feature
Specific insolvency administrator
CP becomes static. Risks to address for continuation:
Lower recovery Back-up loan servicer
Liquidity gaps possibility to borrow, soft bullet arrangement (maturity
extension, typically 1 year), conversion into a pass trough structure
If portfolio liquidation unavoidable:
Legal validity of voluntary OC: critical
In case of shortfall: recourse to the general insolvency estate
(pari passu typically)
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Challenges
1.
Depositors’ subordination and asset
encumbrance
2.
Withstanding financial crises
3.
Fitting in national contexts
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Depositors’ subordination / Asset Encumbrance
CBs by commercial banks
the protection of depositors, primary goal of prudential frameworks, implies a
priority over other creditors, competing with secured claim holders
Some banking laws had to be changed to accommodate CB frameworks :
Australia, New Zealand
CB Overcollateralization (OC): the critical aspect
A wider issue:
CBs not the only driver of unsecured creditors’ subordination
“The real question: the ratio unencumbered assets /unsecured debt”* and its
capital adequacy implication
A strong need: measuring the degree of encumbrance
Protection of depositors
Ability for the issuer to manage funding crisis by offering collateral
Assessment of assets available in a resolution situation
Another frequent claim ranking issue: salaries and tax privileges
*Ralf Grossman, EMF Mortgage Info February 2013
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Asset Encumbrance – Selected Regulatory answers
Link CBs issuance to soundness criteria
Licensing criteria
Minimum solvency ratios
Italy : limits for cover pool size:
None if Capital ratio > 11%
60% if Capital ratio = 10%-11% & tier 1 capital > 6.5%
25% if Capital ratio = 9%-10% & tier 1 capital > 6%
Hard limits
- from 4% to 20% in various jurisdictions
Regulation
Cases by case approach (UK, Netherlands)
Capital requirement to OC
Denmark (capital center), Netherlands
Contribution to Deposit Insurance Schemes
Not a tested solution
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The robustness of Covered Bonds
Has it been tested in the recent financial turmoil?
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A Global Resilience to the Financial Crisis
2008-2009 New issues in Europe remained strong
Source: ECBC
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… but with shorter maturities
Source: Euromoney:
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CB spreads parallel sovereign bonds Why?
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Governments step in before the CB mechanism is
enforced in stress situations
Spain: Cedulas Hipotecarias
Other State bail-outs :
Most CH downgraded to [A-, BBB] –fall of the housing market, risk of lower OC, insufficient transparency
(i.e.no indexation of LTVs),high commercial RE components.
Strong government measures (MOU) for financial system restructuring / orderly resolution –bad bank,
resolution entity- : up-stream strengthening, before reliance on cover pools
Bankia’s partial nationalization (SIFI), 2012
Hypo Real Estate / Depfa Group(Ger), 2008 : nationalized
Anglo Irish Bank 2008-2010: nationalization, creation of a new bank, winding down entity with CBs downgraded to BB-, then redeemed
Dexia (Fr/Belgium), SNS Reaal (NL): nationalized + senior unsecured bondholders bail-in (SNS)
3CIF (Fr), 2012,: Government guarantee
Cyprus (Bank of Cyprus, Cyprus Popular (Laiki) Bank)
Before the crisis: rating uplift (1 notch) limited by the marketability of assets , inefficient foreclosure
process. Covered bonds = BBBFebruary-March 2013 crisis:
Severe downgrade of the country rating (B)
BC& CPB in default, but BC to be bail-out by the government and CPB merged into it
Cov Bonds excluded from the bail-in measures, contrarily to large depositors
CPB Cov Bonds downgraded to Caa
But all the Cypriot CBs were retained by the 2 issuers (to access ECB liquidity support), several
were cancelled, hence not a significant test
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Efficiency of Covered bonds in insolvency situationLessons for recent experiences
Despite the lack of full security enforcement, recent experiences show
some key conditions for the actual efficiency of CB mechanisms in
insolvency scenarios:
No or remote bail-in risk, a major status in the recent bank failures, to be
confirmed by regulation
Dynamic overcollateralization capacity
Market maturity and size (potential buyers / alternative servicers for the cover
pool)
Sovereign rating –even for domestic investors (government's capacity to
provide support if other solutions fail)
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Conclusion: Introducing CBs- Some Key Conditions
Lenders:
Standing
Critical mass
Shortage of stable liquidity (Loan-to-Deposit Ratios, ALM constraints)
Investors:
Critical mass
Need of long term investment instruments
Adjusted investment rules
Market structure:
Strong supervision capacities
Availability of credible alternate servicers / mortgage business buyers –
pass through option: a way around the lack thereof
Legal framework:
Exemption to basic bankruptcy law,
Bail-in of CB holders excluded from bank resolution/restructuring
Legal validity of OC above statutory minimum
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