Transcript Slide 1
Asia Pacific Union for Housing Finance
Delhi Conference January 2012
The Expansion of Mortgage Covered Bonds:
Market Drivers, Policy Options
Olivier Hassler
[email protected]
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Foreword: The World Bank Support to
Housing Finance Development
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A Critical component of Social and Economic
Development…
World needs c 4,000 houses an hour to keep up with
demand (UN-Habitat, 2005)
Urbanization requires huge investments – or slums
prevail
Individual and social impact of immediate decent
housing
Possible wealth ladder
Impact on the economy
Construction multiplier effect
Link home owner ownership /micro or small business
Limits of government finance
Promotion of savings and development of capital market
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…But faces challenges
Among others, HF :
Can
have an adverse effect on banking stability
(linkage with real estate market cycles or bubbles,
risky lending practices)
Imply long term finance to make large investments
affordable, a feature often hard to match
The World Bank’s 4 Pillar Strategy:
Build
sound foundations of HF systems
Expand access of LI households to HF
Promote affordable housing supply
Develop adequate funding for housing
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What are Covered Bonds
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CB Essence : to Provide Security to Investors
1.
2.
A Double Recourse Mechanism:
Mortgage portfolios are pledged to bondholders (Cover Pool)
Bondholders’ privilege on the CP in case of insolvency
CP segregated from other assets
The CP must be sufficient to service the bonds at any time
Quintessential principle: insolvency not an Event of Default
no automatic acceleration of the maturity of the CB
Quality Requirements for the Assets
Strict eligibility criteria: first mortgage, Max LTVs (80% for residential
typically, insurance /guarantees if more), valuation rules, limits on CRE
3.
On going supervision by specific controllers/trustees
However, not a totally Bankruptcy Remote Instrument
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The Expansion of Covered Bonds
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A Fast Growing Market
Amounts outstanding - Billion Euros - Chile , Korea not included
Source: ECBC
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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
But spreads widened in Europe (AAA: 150 bp +) – largely sovereign effect
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
But government supported CB issuers during crises (France, UK, Germany)
No moral hazard (credit risk retained)
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Access to Central Banks’ repos with small haircuts
A Greater Resilience to the Financial Crisis
New issues in Europe remained strong - Source: ECBC(But with shorter maturities)
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Changing Funding Patterns
Importance of short term liquidity risk re-discovered
Wholesale short term funding for mortgage portfolios out
Stable core deposit bases revalued
Securitization affected by the crisis (image, new regulations)
Geographic expansion of covered bonds, including in jurisdictions
that up to now prevented commercial banks from issuing secured debt
New legal frameworks
- Australia
- Korea
- New Zealand
Legal frameworks considered/prepared
- India
- Belgium
- Brazil
- Canada
- Japan
- Mexico
- Morocco
- USA
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Options for Key Features
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Structural Options
Specialized lenders ( initially) vs commercial banks
(general case now)
Asset mix (residential, CRE, public entities), or specific
cover pools by asset types?
Ring fencing options:
CP
register (fungible assets, dynamic pool)
Special subsidiary fungible assets, (dynamic pool) –
France, Australia
bond specific CP
Denmark / Chile models
(static pool, pass through structure)
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Management of Insolvency Situations
Ring fencing legally binding
Specific insolvency administrator
CP becomes static. Risks to address for continuation:
recovery Back-up loan servicer
Liquidity shortage possibility to borrow, soft bullet
arrangement
Lower
If portfolio liquidation unavoidable:
Legal
value of voluntary OC
In case of shortfall: recourse to the general insolvency estate
(pari passu typically)
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Assets/Liabilities Matching
Cash flow coverage: a not precise enough principle
Liquidity risk:
Substitute assets
Pre-maturity test and liquidity reserve (Germany,
France: 6 months in advance)
Market risks:
NPV coverage
Derivatives included in the CP
Better matching = lesser OC requirement
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Depositors’ Subordination
Depositors ranking behind secured creditors: a concern of
many prudential Authorities. Ways to address it:
1.Link
CBs issuance to soundness criteria
Licensing criteria
Minimum solvency ratios
Italy : limits for cover pool size:
2.
Hard limits - from 4% to 20% in various jurisdictions
3.
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%
Regulation
Cases by case approach (UK, Netherlands)
Impose capital requirement to OC
Denmark (capital center), Netherlands
4.
Contribution to Deposit Insurance Schemes
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Conditions of Success beyond Legal Frameworks
Institutional Investors: investment guidelines
Specific asset class, adjusted risk concentration rules, etc.
Investing banks:
Lower
risk weight
Repo-ability
Reporting and market information
Transparency
(dynamic pool composition, on going LTVs,
NPL, etc.) allows less OC
Loan by loan information (UK) maybe excessive (no asset
transfer)
Support to market liquidity
market making ideally, but hard to hold commitments in
stressed contexts
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