Housing Finance and the Capital Markets

1
Housing Finance and the Capital Markets

• Douglas Diamond
• AIPRG Workshop
• 29 May 2005

2
Why Need the Capital Markets?

• In many countries, the bank deposit base is
  enough
• Depends on the size, term, and mostly overall
  stability of banking deposits
• Depends on demand for housing finance vs. size of
  banking sector
• Usually not a problem up to 20 of loans
• Depends on types of loans that are popular and
  rate of prepayments
• Depends on liabilities of institutional investors

3
1st Conclusion Ask.

• Is it likely that the capital market will develop
  faster than banking sector?
• What are prospects for exceptionally rapid growth
  of mortgage demand?
• Where is the line between enabling and
  distorting?
• Tax advantages?
• State-sponsored facility?

4
Modes of Access to Capital Markets

• Lender-based corporate bonds
• Lender-based covered mortgage bonds
• Lender-based securitizations
• Liquidity facility corporate bonds
• Centralized mortgage bank mortgage bonds
• Conduit Securitizations

5
Covered Mortgage Bonds

• Standard corporate bonds
• specific collateral/ overcollateralization
• Segregated in case of bankruptcy
• special supervision
• Spanish vs. German/Danish
• Latter involves special institutions
• German has very conservative LTV
• Spanish has less need for balancing restrictions
• More useful tool for general ALM

6
Securitization

• Loans are sold to a special purpose legal entity
  (SPV) that holds title to the loans and manages
  and passes through all cash received from the
  loans
• SPV has no operating business and no tax exposure
  
• Participations are tradable, but hard to value.
• Can sell different classes of participation to
  different kinds of investors
• E.g., some investors bear the default losses,
  some get the early prepayments, others get very
  predictable cash flow and return

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Securitization (2)

• Overall, it is not cheap or easy, so usually done
  only when there are special reasons
• In Australia, SA, and UK, done on VRMs so as to
  use call centers and agents for originating
  loans, not cheaper funds not dominant in any of
  these
• It is big in the US because Fannie/Freddie offer
  both
• Implicit government guarantee (reduces capital
  costs, created large market)
• Takes on the deadly prepayment risk of Fixed Rate
  loans
• Regulatory arbitrage

8
Liquidity Facility

• Liquidity Facilities provide temporary refinance,
  relying on mortgage assets for security
• Usually refinance is for 1-5 years (3 is
  favorite)
• As supplement to deposits, e.g., 10-30
• Usually obtains funding by issuing simple bonds
• Banks can do this also, so LF has to be cheaper
• Essentially a central mortgage bond issuer
• Always state sponsorship, but better not state
  ownership or guarantee
• Low risk due to high safety, not state guarantee

9
Centralized Mortgage Bank

• Provides permanent refinance. Takes on all
  funding risks, looks like a German-style mortgage
  bank
• With or without recourse
• Kazakhstan Mortgage Company
• Fannie Mae
• More profit by keeping the funding risks and
  employing derivatives to manage them.
• Giant hedge fund
• Who can take on those risks better in Armenia,
  the banks or a centralized mortgage bank?

10
Conduit

• Centralized Securitizer
• Provides permanent refinance. Takes on all
  funding risks, but passes them to investors
• Not always state-sponsored
• Private entities in the US for large loans
• Fannie Mae from 1980-1995
• Implemented in HK, KR, MY

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Hazards of State-sponsored Entities

• 1. Start off low-risk, but politicians may use
  for populist policies
• Kazakhstan, Ukraine (?), Philippines
• 2. If business is weak, entity may be granted
  more subsidies to succeed
• Hungary
• 3. Private interests may take advantage of state
  sponsorship
• Fannie Mae