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

2. 9/11/2015 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. 9/11/2015 3 Securitisation – OECD ”work” definition 1.Process whereby an institutional unit raises funds by issuing securities and 2.enabling the investors investing in these securities to buy directly parcels of specific financial assets 3.Securities are issued to fund assets and the cash flow of the underlying assets represents the interest claims of the securities issued 4.Increasing complexity with the emergence of financial intermediaries: special purpose entities (SPEs)

4. 9/11/2015 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. 9/11/2015 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. 9/11/2015 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

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8. 8 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)

9. 9/11/2015 9 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.

10. 9/11/2015 10 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.

11. 9/11/2015 11 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.

12. 9/11/2015 12 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

13. 9/11/2015 13 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

14. 9/11/2015 14 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.

15. 9/11/2015 15 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

16. 9/11/2015 16 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

17. 9/11/2015 17 DMCS and financial stability This foundation has contributed to stabilizing the Danish economy –Mortgage lending continues during crises (Figure 1)

18. 9/11/2015 18 Figure 1. B ank and mortgage lending to households and NFI

19. 9/11/2015 19 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)

20. 9/11/2015 20 Figure 2. Mortgage lending to households

21. 9/11/2015 21 Securitization – OECD ”work” definition 1.Process whereby an institutional unit raises funds by issuing securities and (TRUE) 2.enabling the investors investing in these securities to buy directly parcels of specific financial assets (TRUE) 3.Securities are issued to fund assets and where the cash flow of the underlying assets represents the interest claims of the securities issued (TRUE)

22. 9/11/2015 22 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

23. 9/11/2015 23 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

24. 9/11/2015 24 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