Refinancing of mortgage loans:
An international comparison
by Prof. Dr. Stefan Kofner
Institute for Transformation, Housing and Social Spatial Development
at Hochschule Zittau / Görlitz
2
Contents
1. Introduction
2. Classic Refinancing with the „Pfandbrief“
3. Alternative refinancing by securitization of claims 4. The costly prepayment option
1. Introduction
4
Introduction
a refinancing market for long- term credit capital:
prerequisite for financing
real estate investments with outside capital
a special importance of the refinancing market for the property markets and the national economy
a two fundamental
organisational alternatives
`continental-European mortgage bond system („Pfandbriefsystem“)
`anglo-saxon securitization system
Funding alternatives of a retail lender
Primary Mortgage Lenders / Deposit Taking Institutions
Liabilities
Equity Assets
Advances
(Collateralized with mortgages)
Mortgage Bonds
Debentures Notes
Retail Deposits
Investors
Liquidity Facility
refinancing bonds
•Pension Funds
•Mutual Funds
•Insurance Companies
•Depository
•Foreign Investors
•Retail investors
Only for Deposit Taking Institutions
Source: Loic Chiquier, World Bank, WBG Workshop Mortgage Finance 2000 MBS through
SPV
Asset Sales
SMM Conduit
Whole loan sale
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2. Classic refinancing with the „Pfandbrief“
2.1 Functions and importance of German type mortgage banks (Hypothekenbanken)
a specialised banks
a long-term „real loan business“
(Realkreditgeschäft)
a state credit: community loan business
a assumption: small loss risk
a Specialist Bank Principle:
`specialisation advantages
`special competence
`strong market position
a refinance of the lendings
`special type of covered
mortgage bond: “Pfandbrief”
`usually fixed rate
`no prepayment option
`largest segment of the German bond market
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Outstanding loans of private
Hypothekenbanken in Germany
in Prozent 1970 1980 1990 2000 2003 Kreditbanken 4,67 9,68 13,78 21,16 20,49
Großbanken 0,42 4,26 6,84 12,84 11,56
Regional- und sonstige Kre- ditbanken (einschl. ausländi- sche
4,10 5,28 6,73 8,31 8,93
Privatbankiers 0,14 0,14 0,20
Sparkassenorganisation 31,49 29,53 29,83 32,44 32,82
Landesbanken 8,33 8,56 6,67 7,40 7,25
Sparkassen 23,16 20,96 23,16 25,04 25,57
Bausparkassen 16,66 19,67 12,94 9,17 9,43
Private 10,65 13,22 8,97 6,37 6,69
Öffentliche 6,02 6,45 3,97 2,80 2,74
Genossenschaftsverbund 4,88 9,54 11,09 14,11 14,71
Zentralbanken 0,18 0,50 0,24 0,11 0,07
Kreditgenossenschaften 4,70 9,04 10,85 14,00 14,64
Realkreditinstitute 33,02 23,78 21,88 13,94 13,01 Private Hypothekenbanken 11,98 11,83 13,64
Öffentlich-rechtliche Institute 21,04 11,95 8,25 Kreditinstitute mit Sonder-
aufgaben 0,99 0,54 2,22 3,09 3,21
Versicherungsunternehmen 8,30 7,27 8,27 6,10 6,31 Gesamt 100,00 100,00 100,00 100,00 100,00
Distribution of market shares
in housing finance in Germany
source: Immobilien &
Finanzierung, 55. Jg. (2004), S. 284 f.
10
Pfandbrief Issuers - overview
Quelle: Verband Deutscher Hypothekenbanken Quelle: Verband Deutscher Hypothekenbanken
12
VDH member banks
2.2 Hypothekenbanken as brokers between capital supply and capital demand
Advantages for an investor (compared with direct loan):
a no due diligence assessment of the loan
a Pfandbrief: fungible security with established secondary markets
a lot size transformation
a risk transformation: diversified portfolio
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2.3 Measures safeguarding
the Pfandbrief creditor
safeguarding measures (1/2)
a „congruent coverage“
(“Refinanzierungskongruenz“):
interest rate changes
`accordance of the term
structure on the asset and on the liabilities side of the
balance sheet: no term transformation
`if not: appropriate measures (e.g. swap businesses).
a specialist bank principle a „coverage principle“:
„Deckungsprinzip“
a priority of the Pfandbrief creditors’ claims in case of
bankruptcy of the emitter (to be satisfied out of the covering
values)
a Registration of the covering
values into the „cover register“
(„Deckungsregister“)
a Regular examination by a trustee
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safeguarding measures (2/2)
a quality of the covering values
`lending value < market value:
sustainable value
`loan to value ratio: 60 per cent of the market value of the pawned property
a higher equity capital requirement for Hypothekenbanken
a circulating limit: liable equity capital times 60
Pfandbrief - solid shelter for investors
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regular
collateral values mortgage loans
substitute collateral values (< 10%)
other assets
equity capital Hypotheken- pfandbriefe
Öffentliche Pfandbriefe
other refinancing funds
balance balance
A A P P
state loans
2.4 Internationalisation of the Pfandbrief
a “Jumbo-Pfandbriefe”
a Answer to the segmentation of the Pfandbrief market
a fixed interest finally due papers
a annual interest payment a emission volume: at least
500 million Euros
a consortium of emitting banks: provides for the liquidity and fungibility of the emission
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2.5 Amendment of the mortgage bank law
a expansion of the range of business within and outside Europe a acceptance of derivatives as covering values
a permission to operate additional businesses (e.g.
administration and brokerage of mortgage and state loans, real estate agent activity, valuations and location analyses)
2.6 Opening up of the Pfandbrief market?
a omission of the emission
monopoly of the special banks a Pfandbrief business to be opened
up to every credit institution
which fullfills minimum require- ments and possesses a Bafin
license
a instruments taken over from the existing mortgage bank legis-
lation include loan to value ratio, trustee principle and regular
covering mass examinations by the Bafin administration
minimum requirements:
a core capital of 25 million Euros a regular emission activity
a suitable instruments for the
control, monitoring and check of the risks incorporated in the
covering masses
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2.7 Comparison of the Romanian and the German mortgage bank regulation
Germany Romania
Entered into force 1.1.1900 9.12.1999 Specialist bank
principle yes unclear
Term protected by
law Yes (Pfandbrief) Unclear (obligatiunile ipotecare) Refinancable through
mortgage bonds Mortgage and public sector loans
Mortgage loans
Cover register yes No
Legally anchored preferential right in bankruptcy
yes No
Valuation regulations yes No (relative) lending
limit for funding through mortgage bonds
60 % of
mortgage lending value
60 % of value of portfolio
Absolute lending
limit Basically no (100
% of market value)
No
Germany Romania
Limit for lending beyond the cover (volume above the relative lending limit)
20 % Unlimited
trustee yes no Substitute collateral yes no
Limit for substitute
collateral 10 % no
Public-sector bond Yes no Special ranking of
cover mortgages No no
Specialist public
supervision Yes no
Art. 22 (4) UCITS
directive fullfilled yes no
Comparison of Mortgage Bank and „Pfandbrief“ laws in Romania with German legislation (24.9.2002) Quelle: Verband Deutscher Hypothekenbanken
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3. Alternative refinancing by securitization of claims
a Mortgage backed securities (MBS): covered bonds
which securitize real estate credits
a ability to repay: stream of principal and interest
generated by the underlying assets
a role of banks: no more risk takers, but mere mediators (financial intermediaries) a U.S. mortgage market:
federally promoted
institutes Freddie Mae and Fannie Mae most important emitters of MBS
Asset-Backed Securities (ABS i.w.S.)
Mortgage-Backed Securities (MBS)
Asset-Backed Securities (Non-MBS, ABS i.e.S.)
• car finance
• credit cards
• commercial credit
• leasing rates
• ...
• residential mortgage credits
• commercial mortgage credits
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U.S. Securitization Activity, 1987-2001
- 500 1.000 1.500 2.000 2.500
1987
1989 1991 199 3
1995
1997 1999 200 1
US$ billions
ABS MBS
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European Securitization - 2001
by Country of Collateral
Groß
britannien
Italien
Niederlande
Deuts
chland
RMBS ABS 48,8
34,1
17,5
4,2 19,0
11,3
9,0
1,2 0,0
5,0 10,0 15,0 20,0 25,0 30,0 35,0 40,0 45,0 50,0
Mrd.Euro
Quelle in Anlehnung an: ESF Securitisation-DataReport (Spring 2002)
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3.1 The basic structure of the
securitization of claims
The Originators’ perspective
a real estate financing institution, e.g. bank,
insurance, building society a needs favourable credit
rating and widespread
portfolio of homogeneous mortgage credits
a defines a bundle of
mortgage credits for the purpose of outsourcing it from his balance
`capital is liquidized
`risk transfer
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Trustee
Originator Special Purpose
Vehicle
Debtor
Investor Consortium
Enhancer
Rating-Agency interest/principal
sale of assets
purchase price
payment/
claim payment
obligation
investment placement
emission emission revenue
interest/principal
interest/principal
quality valuation credit
enhancement
cash flow investment
basic structure of an MBS-transaction source: Leta Bolli: “Asset Securitization”,
presentation at Seminar Finanzintermediation, Zürich University, summer semester 2002
3.2 The role of the rating agency
a first-class rating indispensable
a agency examines adequacy of the issuing price of the bonds a repayment stream: expected value and statistical deviation a role of credit enhancements
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3.3 Costs und treatment in the balance sheet
a The costs of such securiti- zation transactions are not to be neglected.
a non-recurrent costs for the preparation and structuring of the transaction, emission and listing costs
a current costs: for trustees, guarantees, rating agencies, bank consortium
debt capital
equity capital
cash loans
financial and tangible assets,
other assets,
etc.
balance originator
debt capital
equity capital
cash loans
financial and tangible assets,
other assets,
etc.
balance originator
loans
debt capitalbalance SPV
consequences of an MBS-transaction on the balance sheet source: Leta Bolli: “Asset Securitization”, presentation at Seminar Finanzinter-mediation, Zürich University,
summer semester 2002
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3.4 The investors’ perspective on MBS
a attractive rate of return
a estimation of the failure risk by rating procedures
a access to a diversified portfolio
a fungibility because of securitization (but
secondary markets still underdeveloped)
3.5 Comparison with the German Pfandbrief system
a two competing refinancing instruments a MBS as supervision arbitrage?
36
Hypothekenbank as a protective institution
a Pfandbrief emission:
entire credit risk is with the mortgage bank, whole
emitter portfolio of mort- gage credits serves as
„Deckungsmasse“
a MBS transaction: only specific credit bundle
(repayment stream) serves as collateral for the outstanding bonds
Control and safeguard instruments
Pfandbrief:
a numerous regulatory safeguard instruments
MBS:
a no regulatory safeguard instruments (law, state supervision)
a investors need to rely upon the rating
a intransparent market for MBS emissions
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Pfandbriefe versus MBS
MBS:
a more flexible and closer to the market requirements,
a appropriate for the securitization of credits which do not fullfill high quality standards,
a complex product, needs explanation
a monitoring-intensive investment
Pfandbrief:
a Superiority of the Pfandbrief as far as the failure risk is concer- ned: high quality standard of the individual covering credit
a smoothly working secondary markets
a homogeneity and transparency of the Pfandbrief system: saves
information costs
4. The costly prepayment option
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Different usances
Germany:
a prepayment of a mortgage loan either excluded or sanctioned a debtors stuck to fixed interest
rate
a usually no prepayment option on the refinancing side
U.S.:
a prepayment option
a used by many debtors when interest rates fall
a prepayment option usually also on the refinancing side
a There is no such thing as a free lunch
`compensation: higher interest rate level on both sides
`increases with higher interest rate volatility
`Are capital markets working efficiently?
`If yes, debtors should be indifferent
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Superior efficiency of the German institutions?
Unadjusted price
Adjusted for
interest fee Refinance Credit risk Value of prepayment option
Adjusted price
Denmark 5,10 0,09 3,83 0,06 0,46 0,84 Germany 4,77 0,07 3,99 0,09 0,06 0,70 France 4,93 0,17 3,79 0,13 0,29 0,89 U.K. 4,80 0,07 3,60 0,12 0,01 1,15 Italien 4,68 0,04 3,00 0,19 0,20 1,34 Netherlands 4,39 0,16 3,30 0,08 0,20 0,97 Portugal 3,53 0,06 2,46 0,17 0,00 0,95 Spain 3,44 0,11 2,40 0,12 0,00 1,03
Source: Mercer Oliver Wyman
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Unpleasant choice?
Pro prepayment option:
a consumerism
a supposed macro-economic benefits
a increases competition
Against prepayment option:
a monitoring intensive, unfair a high interest rate premiums in
volatile capital markets, e.g.
Romania
a difficult calculation of the option prices
a considerable administrative costs Efficient
Efficient solution:solution:
-- letlet bothboth arrangementsarrangements competecompete -- freefree choicechoice of of debtorsdebtors
