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Securitisation and the Danish mortgage credit system

Securitisation and the Danish mortgage credit system. WPFS WORKSHOP ON SECURITISATION Madrid, 27-28 May 2010. Maria Jose Alvarez Pelaez. We will talk about. Securitisation: Definition(s) why the interest to compile statistic? Characteristics of the Danish mortgage credit system (DMCS)

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Securitisation and the Danish mortgage credit system

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  1. Securitisation and the Danish mortgage credit system WPFS WORKSHOP ON SECURITISATION Madrid, 27-28 May 2010 Maria Jose Alvarez Pelaez

  2. 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?

  3. Securitisation – OECD ”work” definition • Process whereby an institutional unit raises funds by issuing securities and • enabling the investors investing in these securities to buy directly parcels of specific financial assets • Securities are issued to fund assets and the cash flow of the underlying assets represents the interest claims of the securities issued • Increasing complexity with the emergence of financial intermediaries: special purpose entities (SPEs)

  4. 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.

  5. 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 requirements • b) risk transfer • c) diversification of funding

  6. 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

  7. 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)

  8. 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 .

  9. 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.

  10. 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.

  11. 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

  12. 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

  13. 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.

  14. 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

  15. 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

  16. DMCS and financial stability • This foundation has contributed to stabilizing the Danish economy • Mortgage lending continues during crises (Figure 1)

  17. Figure 1. Bank and mortgage lending to households and NFI

  18. 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)

  19. Figure 2. Mortgage lending to households

  20. Securitization – OECD ”work” definition • Process whereby an institutional unit raises funds by issuing securities and (TRUE) • enabling the investors investing in these securities to buy directly parcels of specific financial assets (TRUE) • Securities are issued to fund assets and where the cash flow of the underlying assets represents the interest claims of the securities issued (TRUE)

  21. 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

  22. 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

  23. 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

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