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|
Current Market Environment in Bangladesh
| - Recognized key socio-economic impacts (growth, private
sector, social safety, wealth and savings, etc.) |
| - Sizeable part of the broader financial sector
(market-base integration, liberalization, stabilizer or
leveraging role) |
| - Room for expansion & social penetration (housing
finance constrains urban development) |
| - Diversified primary market: about 10 lenders, volume
becoming significant (Tk 75 billion 2003), 3 dynamic NBFIs
that strongly need new capital sources |
| - New legal framework anticipated for
2005 | |
Existing Portfolios
Unsuitable for Securitization
| -
High NPLs (except for the 3 specialized lenders) |
| -
Rates adjustable at lender discretion incompatible with loan
sales
|
| -
Equitable mortgages prevent securitization for operational
reasons (lenders keep physical titles)
|
| - Market infrastructure conditions fall
short |
|
-
Property/security right registration still largely
unreliable
|
|
- Efficacy of
new, extrajudicial foreclosure procedure remains to be
tested
|
| - Securitization started in India in similar
environment
|
|
- consequence
has been high transaction costs including oversized
anti-default buffers.
|
|
- Also, market
restricted to specialized lenders with proven expertise in
managing credit risk
|
| - Likely to be same in Bangladesh (only 3
specialists will be acceptable for investors, other lenders
must first gain recognition in their risk management
capacity)
|
|
Mortgage Market May
Not Develop Spontaneously
| - Uncertainty as to investors’ protection against credit
or prepayment risks : |
|
- inherent to infant markets, but may be dissuasive |
| - Absence of “market” for credit risk (insurers,
guarantors, low grade investors): a major stumbling block for
securitization |
| - Cannot skip basics: legal, regulatory, collateral,
macro, standards, competition, etc. pre-conditions to be
analyzed |
| - No housing finance miracle if inadequate supply of
low-middle-income housing and of titled land |
| - Dual challenge: (1) manage credit and market risks (2)
adequate accessibility and affordability to homebuyers |
| - Legal frameworks for financial instruments: |
|
- Adjustment of the bankruptcy law/true sale
conditions |
|
- Fiduciary arrangements |
| - Robust market infrastructure |
|
Government Role in
Market Development
| - No
direct lending but regulator, market catalyst, provider of
infrastructure & subsidies (complex)
|
| -
Relatively low depth in financially developed systems
sometimes due to large share of public housing |
|
- France,
Chile |
| -
Conversely, depth (or high growth) is sometimes related to
large government support |
|
- USA: large
interest tax deductibility (0.6% GDP), govt backing of FHA/VA
(15% market), GSE implicit guarantee (over 50%
market) |
|
- Netherlands:
total interest deductibility, tax exemption on savings plans,
government backed guarantee fund |
|
- Hungary:
subsidies on mortgage bond financed loans, tax exemption for
mortgage bond holders, tax break for mortgagors on top of
direct demand subsidies | |
Inducing Market
Development
| - Banks may be reluctant to develop housing finance, or
act as an oligopoly: priority to high margins over high
volumes.
|
| - How
to jump start a market or overcome a market
failure?
|
| 1. |
- Credit direction, margin control: counterproductive,
likely to be damaging for the supply of finance in the long
run
> Need of a “ market maker” or
market engine |
| 2. |
- State Housing Banks: a frequent temptation,
only exceptionally successful (National Housing Bank
in Thailand, BancoEstado in Chile) |
|
|
- Access to privileged funding (MOF, Central
Bank) : |
|
|
|
- Kills the
commercial supply |
|
|
|
- Does not
foster the development of sustainable long term
capital |
|
|
|
- Often
benefits to ill- targeted groups |
|
|
- Permissive lending and high NPL
rate |
|
|
- Major governance
issues |
|
Examples of
Government Interventions
| - Provision of funding (Chile
1977-1980) |
| - Provision of credit enhancement
(Mexican SHF) |
| - Creation of second tier
facilities with a catalytic purpose (ex. of successes :
Cagamas, Jordanian JMRC) |
| - Assumption of macro-economic
risks (wage/price index swap in Mexico) |
| - Incentives to the market
liquidity of securities (repo facility in
Colombia) | |
Why capital markets
are important for mortgage lending
| - Long loan amortization periods (key of
affordability) + fixed interest rates (desirable to pre-set
them at least for a few years for credit risk
considerations) >
dangerous balance sheet mismatches can
develop (multiple experiences) |
| - Specially risky to rely entirely
on deposits if unstable deposit bases and if no available
hedging instruments (swaps…) |
| - Government funding to remedy the
lack of long term capital generates more problems (unavoidable
rationing, interest distortions, ill-targeted benefits…) that
it solves | |
Investors require
credit enhancement because of long maturities:
| - Central liquidity facilities
(Cagamas in Malaysia, JMRC in Jordan). Dedicated to provision
of funds to lenders, with pledge on loan portfolios, financed
through bond issues |
| - Covered bonds (Europe –including
UK now-, Latin America): debt of lender collateralized by
mortgage portfolios meeting a few, regulated quality norms,
bondholders have privileged status in case of
bankruptcy |
| -
Securitization : |
|
- Ownership of loan portfolio
transferred, investors insulated from deterioration of
lender’s credit (bankruptcy remote) |
|
- Credit risk on loans is
filtered, investors only exposed to residual risk after the
“waterfall” effect of successive cushioning devices, including
external credit enhancement |
|
- Liquidity and interest rate –
especially prepayment risk- risks are shifted to
investors | |
Coverage of
incremental credit risk through insurance
| -
US (FHA, historical model), Canada (CMHC), Continental Europe,
Mexico (SFH), Baltic states, Kazahkstan
|
| -
Criteria: - High LTV (first buyers in particular) |
|
- Income or
price limits |
|
- Unblemished
credit history (FHA) |
| -
Coverage: 70% to 100% |
| -
Government backing - typically: combination actuarial reserves
+ last resort support (catastrophic risk)
|
| -
Cost: typically borne by the borrowers, but lowered by the
government backstop
|
| -
Issue in early stages of a market: few data available, bigger
risk of adverse selection and moral hazard --
pricing difficult, high
cost
|
|
Examples of
Mortgage Insurance
| 1. |
Mortgage substitute (for
lenders) |
| For
lenders, outsourcing to remedy mortgage
deficiencies
|
| (Foreclosure often a lengthy, costly and uncertain
process)
|
| Examples: Algeria (SGCI), France (Credit-logement),
Jordan (JLGC), Slovenia, Mali, West bank Gaza
(PMIF)
|
|
- Purpose :
Transfer, but little mitigation of risks (The source of
inefficiency remains, possible benefits from
mutualization)
|
|
-
Loan criteria : same as lenders, or even more restrictive
(LTV < x% ) |
|
- Coverage :
anticipation of forced sale proceeds, loss sharing
provision
|
|
- Cost borne
by borrowers or lenders |
| Often high cost for the value. Specific conditions to
be successful
|
| 2. |
Mortgage supplement (higher
risk) |
| Loans
with increased expected losses -Typically:
higher-than-normal
|
| LTV,an indicator of
probability of default as well as of severity of
loss
|
| Examples
: USA, UK, Canada, Australia,Thailand (on
going)
|
|
- Purpose:
- efficiency,
risk measurement (mutualization, geographical diversification, modeling)
- secondary mortgage
market requirements
(Fannie/Freddie in the
USA)
|
|
-
Criteria : insurance required if
LTV > y% (75%- 80%
typically) |
|
- Coverage : first
loss –20% to 30% typically, excludes catastrophic
losses
|
|
- Cost
borne by the borrower |
|
MBS Require
Sophisticated Markets
| -
Valuation is major issue, MBS are complex securities that
require investor skills & above all information. A robust
historical series & public information regarding portfolio
past & prepayment behaviour is required.
|
| -
MBS also require an appropriate infrastructure (e.g.
transparency obligation, dissemination vehicles) to enable
sound pricing procedures.
|
| -
Securitization of mortgages more difficult than other assets
(e.g. IPDC securitization). Uncertainty in the value factors
translates into high premium, making transactions
costly.
|
| -
Although mortgage bonds and mortgage backed securities look
similar, they have distinct characteristics
|
|
- Outright vs
contingent transfer of credit risk |
|
- Transfer of
financial risk to capital market vs A/L management by
financial intermediaries
|
|
-
Standardized loans vs standardized
securities
| |
Mortgage Related
Securities
| 1. |
Direct goal: hedging financial intermediaries'
risks |
| 2. |
Indirect impact: |
|
-
Promote primary market discipline |
|
|
Investors’
confidence in the primary market required (lending standards,
efficiency of collateral, quality of recovery)
|
|
|
… sometimes
with the help of regulation: special foreclosure procedures
for loans refinanced by capital market (Chile, Poland,
Argentina), lending quality norms (mortgage
bonds)
|
|
-
Foster capital market development |
|
|
Often,
institutional savings lacks investment vehicles (->
low-return, short term or foreign currency investments)
|
|
|
An
archetypical experience: Chile (parallel take off of
reactivated mortgage bonds and newly created pension funds
after 1980)
| |
Mortgage Bonds
| - A
decentralized, covered debt instrument: double security
level
|
|
-
General obligation of the issuer |
|
-
Lien on loan portfolio in case of insolvency (exception to
bankruptcy law)
|
|
-
Regulated portfolio quality (typically: 60% to 75%
LTV) |
| - A
regional instrument: continental Europe (20% of mortgage
loans) and Latin America, but ongoing diversification:
|
|
-
geographical : European transition economies (Poland, Hungary,
Bulgaria, Czech Republic…), UK, Peru, Colombia
|
|
-
Linked to technical strengthening (structured finance
methods):
|
|
|
- Modernized
cover principle (Net Present Value) |
|
|
-
Strengthened bankruptcy privilege: asset ringfencing, explicit
exclusion from bankruptcy estate, non-acceleration principle,
prior claim over other asset instead of
OC…
| |
| MBS are most suited
to: |
|
- Large
countries or zones where credit risk diversification has much
sense (ex.: India, Mexico)
|
|
- Lenders
whose size, specialization or history hamper their capacity to
manage financial risks
|
|
- Lenders
with scarce capital base or insufficient rating
|
| -
Expensive, at least initially (agency risk, illiquidity
premium, credit enhancement based on worst case scenarios),
but cost to be balanced with benefits (rating upgrade, economy
of capital, transfer of risks)
|
| - A
tool that needs a long maturation period (data series for
valuation, availability of credit risk buyers)
|
| -
Securitization in emerging countries tends to start with ABS
rather than MBS, contrarily to the historical path in
developed economies
|
| Mortgaje Bonds are most
suited to: |
|
- Lenders
of fairly good standing
|
|
- Lenders with nationwide networks
(credit risk diversification)
|
|
- Market liquidity enhancement
|
|
- Cheaper than MBS, - simple, more liquid,
regulation vs expensive risk cushions
|
| - No deterioration of
the portfolio average quality |
| - Prepayment risk is a challenge |
|
- If bonds can be callable:
possible inefficiencies (valuation of the financial option
disconnected from the actual prepayment rates) |
|
|
- If prepayment risk kept by the
lender: diversified financial institutions (capable of
internal hedging) more appropriate issuers of MB than
specialized institutions. |
|
- (Another difference with the history of
developed economies)
|
|
Mortgage Liquidity
Facilities
| Centralized refinancing
institutions that pool the funding requirements of lenders and
issue bonds |
|
Examples:
Malaysia (Cagamas Berhad), Jordan (JMRC), Algeria (SRH), USA
(FHLB system) |
| Lend (with
overcollateralization), or buy with recourse: bring long term
liquidity, do not take over credit risks |
| Typically owned by their
users, sometimes with government/Central Bank participation or
support (USA) |
| Specialized, low cost
intermediaries |
| Frequently catalyst
effect on the primary market |
| Drawback: an additional
layer of intermediation | |
Role for Government
| -
Too often: costly, inefficient and inequitable
methods
|
|
- Direct
provision of housing by the government |
|
-
Administratively set rates (kill the finance supply)
|
|
- Misuse of
provident funds |
|
- Allocation
of land with a social opportunity cost that can be huge but
ignored in the absence of proper land market
|
| -
Assistance schemes need to be: |
|
- Explicit
(budgeted) |
|
- Leveraged by
private finance |
|
-
Non-distortive |
|
- An incentive
to more savings, more lending,better housing supply
| |
Government has an
important role to play – but the path between market promotion and
distortion is narrow:
| 1. |
Are there real limitations to
private market solutions (not just a demand to artificially
lower the cost of funds)? |
| 2. |
Is there a risk of price
distortion that would kill the increase of finance
supply? |
| 3. |
Can public institutions
efficiently manage guarantee or funding programs? |
| 4. |
Privatization strategy for when
market has matured & need for incentives have
disappeared |
| 5. |
Do government guarantees or
resources induce market forces to cater to underserved
households? |
| 6. |
Market development can take years.
Creating a framework does not equate creating a market.
|
| 7. |
The development path does not
necessarily replicate the history of more advanced
economies | |
|