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Recent Developments on European Mortgage-backed Securitisation Markets
By European Mortgage Federation
[I am grateful to Judith Hardt [Mailto:Jhardt@hypo.org ]of European Mortgage Federation for permitting me to reproduce this report. For other resources on European mortgage finance, see http://www.hypo.org ] Also see our country profiles for each of these countries.
Quick guide to Mortgage-backed markets in European countries:
Recent Developments on European Mortgage Bond and Capital Markets
On 3 September 1999, the members of the Capital Market and Mortgage Bond Committee met in Vienna to exchange information about mortgage bond markets. These experts were invited to comment in particular on recent economic and legal developments that affect the re-financing of mortgage loans in capital markets. The contributions summarised include reports from Germany, Denmark, Spain, France, Greece, Ireland, Austria, Sweden, Finland, the United Kingdom and Switzerland. Statistical updates when available are provided at the end of the document.
Following the first issue of a jumbo Pfandbrief in May 1995, today in this market segment alone around 270 issues with a volume in excess of DEM 590 billion are already in circulation. The share of the jumbo Pfandbrief in the overall Pfandbrief market has therefore almost doubled within a year, to reach 27%. Only the jumbo Pfandbrief market has reached the 4th place on the list of the largest European issuers in less than five years. With an outstanding of almost DEM 2 trillion, the overall German Pfandbrief market is the largest capital market segment in the world's non-government sector.
Increased liquidity of the Pfandbrief - German issuers have made further efforts to improve the liquidity of the Pfandbrief, and in particular the jumbo Pfandbrief:
The Pfandbrief-future - The attempt made to increase the liquidity of the Pfandbrief market by creating a specific hedge instrument failed. The future on 3.5 to 5-year jumbo Pfandbrief introduced on the EUREX in July 1998 had to be abandoned in the spring of this year despite the underlying volume of DEM 50 billion established by Pfandbrief issuers in a show of strength. The issuers’ attempt to further improve the underlying volume by means of larger-volume issues and stronger ratings also proved unsuccessful in the end. This failure of the Pfandbrief-future was probably due to the fact that with the introduction of the euro, the Bund-Future expanded its market leadership in the Euro-Future Market to over 80%. This gave rise to overwhelming competition from the Bund-Futures and swap market, and there was apparently not sufficient need for a specific hedge instrument among investors. The failure of the Pfandbrief-future therefore had no discernible negative effect on Pfandbriefe sales.
Credit quality - Despite the excellent assessment of the quality of Pfandbriefe by the international rating agencies (the large majority are tripe A rated) there have recently been critical analyses of the ‘real’ quality of Pfandbriefe or rather the issuers behind them in view of the modern financing instruments (derivatives) that the Pfandbrief institutes use to close open positions. To avoid lasting damage to the image of their common product, the Pfandbrief, German Pfandbrief institutes will make transparent and disclose the market price risks taken and the risk management systems applied to limit these risks with the consent of the banking supervisory body. The following measures are being put forward :
Revision of the Mortgage Bank Act - The Association of German Mortgage Banks has suggested revising the Mortgage Bank Act in the context of the 4th Financial Market Development Act which is to come into force next year. This revision concerns the following issues :
Privatisation of the DSL Bank - The government draft states that the DSL Bank – as well as the Deutsche Genossenschaftsbank – may issue « covered » bonds, but these may not be called Pfandbriefe. These bonds, like those of the Deutsche Genossenschaftsbank, are to be reported to Brussels in accordance with Article 22 paragraph 4 of the UCITS Directive.
Danish mortgage bonds are traded on the Copenhagen Stock Exchange (CSE). The turnover of mortgage bonds on the CSE amounted to EUR 432 billion in 1998 divided on about 2,000 bond series (growth of 35% compared to 1997). The higher turnover is primarily the result of repayment activity and the increasing foreign interest in mortgage bonds. The waves of re-financing and the high level of mortgage lending in the recent years have created large bond series (even compared against international standards) and have therefore increased the liquidity. The three benchmark-papers 6% 2029, 6% 2026 and 7% 2029 had a circulation volume of respectively EUR 27, 17 and 15 billion at the end of 1998.
International sales of Danish mortgage bonds have experienced a minor breakthrough. Since the beginning of 1995 foreign ownership of Danish mortgage bonds has increased and by the end of 1998 the nominal volume of mortgage bonds abroad corresponded to EUR 11.9 billion. In some of the benchmark-papers the foreign share amounts to about 25% of the amount outstanding. The reason for this growth may be found in the good rating of Danish mortgage bonds and the attractive profit relative to the Danish Government bonds.
Cédulas Hipotearias - A 10% weighting for mortgage bonds was established by Royal Decree 845/1999 May 21st. This reduces the own funds requirements by half, thereby facilitating their acquisition by national and foreign institutions. This favourable treatment is the result of the translation of article 22.4 of the Directive 85/611/CEE (UCITS) into Spanish law (Law 20/1998 July 1st), which recognises the particular guaranties of mortgage bonds.
The Civil Procedure Law was modified to facilitate and to reduce the costs of the repossession procedure. This will result in a better coverage of the rights of all parties concerned in the mortgage market: the creditor, the holder and the debtor.
Jumbo issues of Cédulas Hipotecarias (CH) by leading mortgage lenders and targeted at both domestic and international institutional investors is one of the most significant developments in the Spanish mortgage market (approximately EUR 1 billion).
Several institutions are in the process of issuing CHs. Argentaria has registered an issuance programme of EUR 3.5 billion for the next months. Caja Madrid, which is the second largest Spanish savings bank, has registered EUR 3 billion. Caja Madrid's issues have been assigned an AAA rating given that CHs are rated two notches above the senior rating of the issuer. BBV has also registered an issuance programme for its mortgage portfolio which amounts to around EUR 10-15 billion. The issue is actively marketed at present. Another savings bank, Caja Galicia, is further interested in issuance of CH during the coming months. The total issuance programme registered with the Spanish authorities amounts to around EUR 9 billion of which around EUR 5 billion worth of CH have been issued.
There are discussions aiming to clarify existing Spanish legislation with reference to the privilege of the holder of the mortgage bond in the event of bankruptcy as there are different legal opinions.
MBS - The outstanding balance of mortgage-backed securities presented exponential growth in the later months of 1998, representing just over 3% of the total balance of mortgages. After some years of very slow development, the process of mortgage securitization has suddenly boomed. In the early months of 1999, the securitization of real estate loans was very dynamic. In the first 8 months of the year, 12 issues of mortgage-backed securities were registered at the CNMV (Spanish SEC) for a total of EUR 5.6 billion. The total amount of mortgages securitized in Spain since 1992, when this process started, is nearly EUR 11.6 billion, three quarters of this has been issued in the last eleven months.
The new law on mortgage bonds (obligations foncières) was passed on 25 June 1999 and banks are now preparing bond issuance. "Société de Crédit Foncier" (SCF) are credit institutions that fund their activity primarily (but not exclusively) through the issuance of obligations foncières (OF) and the holders of the OF have a preferential right on the assets of the SCF. These assets can be mortgage loans or loans to local authorities. The French version of MBS ("parts de fonds communs de créances") can also be included in the pool of assets of the SCF provided that at least 90% of the underlying loans are assets eligible for a SCF.
Credit Foncier de France (CFF) has now set-up a SCF which has been approved by the French banking authorities. The name of this subsidiary is " Compagnie de Financement Foncier " (CoFF). Before the end of this year, CFF will shift eligible assets (loans and securities) and liabilities (obligations foncières) to the balance sheet of this newly-created entity. The amount of this transfer is between 160-180 billion FRF. The SCF became operational on 1 November. Two issuances of obligations foncières are currently being prepared. First, the CoFF will issue obligations foncières secured by eligible MBS (EUR 1 billion to be launched in September). Second, an exchange offer is scheduled for November whereby the CoFF will propose to holders of outstanding CFF bonds an exchange with obligations foncières issued under the new law. The exchange offer will be based on an amount outstanding of FRF 90 billion and a good result would be between 20% to 30% of favourable responses.
There will be several entities exerting corporate control such as a Board of Directors, a President and an independent trustee (contrôleur spécifique). The "contrôleur spécifique" is a financial markets expert and selected from the list of approved accountants whose role it is primarily to (i) verify every three months whether the obligations foncières, and in particular the underlying assets, comply with the legal provisions, and (ii) in the event of bankruptcy of the issuer, manage the liquidation procedure. The "contrôleur spécifique" publishes the results of due diligence exercises once a year. A SCF does not have any paid employees.
Three mortgage financing systems making use of capital market co-exist in France. In addition to securitisation and issuance of obligations foncières, there is the traditional mortgage market on which the Caisse de Refinancement Hypothécaire (CRH) operates. The new mortgage bond law has widened the scope and reinforced the activities of the CRH. The securities issued by the CRH will no longer need to comply with the regulations of the CFF. The new law provides for a convergence of the eligibility criteria for the assets of the SCF and CRH. One consequence of these changes is that the CRH has adapted its company statutes and changed its name to "Caisse de Refinancement de l'Habitat". CRH is among the largest French issuers with total bonds issued exceeding EUR 20 billion. The CRH 5% 2008 has become a benchmark on the European market with volumes outstanding of EUR 3.1 billion.
There is neither a mortgage bond nor an MBS market in Greece. The unfavourable tax regime for corporate bonds (20% tax on interest) compared to Greek government bonds (10% tax on interest) is the main reason for this situation. Furthermore the high interest rates that prevailed during the 1990s and their subsequent gradual fall led banks to rely more heavily on deposit funding. The expected convergence of interest rates during the year 2000 will allow banks to exploit alternative sources of funding such as mortgage bonds and/or MBS.
Greek National Law 3221/24 in its latest version, allows mortgage banks to issue mortgage bonds conferring them the characteristics as described in Article 22(4) of the UCITS Directive 88/220/EEC. This Directive was adopted by Greek National Law 1969/91 Article 33(ay) and Presidential Decree 433 5/7.10.93.
The Greek capital market has experienced a shift of interest in favour of long-term fixed-rate bonds and at the expense of T-Bills and FRNs. Long-term government debt increased significantly since 1996 reaching EUR 66.8 billion at the end of 1998. T-Bills outstanding on the other hand declined significantly since 1996 and amounted to EUR 11 billion at the end of 1998. Preliminary estimates for June 1999 bring this figure further down to EUR 8 billion. Almost 75% of T-Bills are of one year duration.
Greek long-term debt consists of FRNs and fixed-coupon bonds. The last FRN issue took place in 1997 with a duration of 7 years. Since then there has been continuous increase of the fixed-income market through the issuance of 2, 3, 5, 7, 10 and 15-year bonds. Currently fixed-coupon bonds constitute the largest part of long-term debt. New issues of fixed-coupon bonds during 1998 amounted to EUR 16.5 billion. In terms of duration 10-years had 31% of the total share followed by 7-years with 23%. In the first half of 1999, new issues amounted to EUR 14.4 billion and the 10 and 15-years attracted the investors’ interest with shares of 22.8% and 18.7% respectively.
The final convergence in interest rates which will take place in the first half of 2000 coupled with the drachmas locking into Euro will enhance competition from various credit institutions to match their long-term mortgage lending with long-term funding.
The Irish Mortgage & Savings Association (ISMA) has recently endorsed the findings of the « Funding and Resources Growth in the context of EMU » report. Consultants and legal experts are now evaluating the practical steps which should be taken in order to enable Irish lenders to issue mortgage bonds. Results are expected before year-end.
Article 22 (4) of the UCITS Directive has been fully implemented in Austria. At the request of the European Commission (DG Internal Market and Financial Services), the Federal Finance Ministry sent an up-to-date list of the issues falling under the scope of this provision to Brussels in a letter of 7 July 1999. Further legal developments during the first six months of 1998 included the following :
Nevertheless, the market in Austria continues to shrink. As a result of the repayment of loans, particularly in the public sector, issuing activity was adversely affected (down around 20% in 1998 compared with 1997). The volume of bonds issued by Wohnbaubanken (institutions specialised in housing finance, loans with tax advantages) in 1998 exceeded the volume of mortgage bonds for the first time. Under certain conditions, these bonds are exempt from withholding tax.
The rating of mortgage bond has been considered but to date the market has not implemented it.
There have been little regulatory developments in the field of the mortgage bonds. Market participants are still waiting for the Swedish government’s initiative on Article 22.4 of the UCITS directive and MBS-legislation.
The mortgage bond primary market has substantially decreased since 1990 and only a small amount of mortgage bond was issued in 1998. Total outstanding amount of mortgage bonds is less than EUR 1 billion. The share of mortgage bonds of mortgage funding is minimal. With regard to MBS, there is one major issuer of in Finland, namely the Housing Fund of Finland. The Fund has made three major securitisation transactions so far.
The Government Bill on the Mortgage Bank Act has been passed during the summer of 1999. The Act will regulate both mortgage banks and mortgage bonds and will protect the name « mortgage bond ». Mortgage bonds will be structured following largely the German Pfandbrief-model.
Transparency in the domestic market is poor as there are no public quotations for mortgage bonds. However, market making is expected to be extended to mortgage bonds in the next 2 to 5 years.
Liquidity is low mainly because of the small outstanding amount of mortgage bonds and the nature of investor base. The domestic investor base consists mainly of retail investors. There is also institutional demand, but the yield demanded is beyond the retail one. At present, there are no derivatives based on mortgage bonds.
Mortgage bonds are not usually rated and domestic investors have not required it so far. The market development and the market integration within the euro-zone will make rating necessary for Finnish issuers.
Withholding tax on coupons received is 28% but it will be increased to 29% in 1999.
Public issues of MBS have been running at roughly double the level of last year, helped by two jumbo GBP 1 billion (EUR 1.4 billion) issues by Abbey National in February and October. New issues in the first ten months totalled GBP 4.3 billion (EUR 6 billion), equivalent to 4.5% of total mortgage lending in the period.
Mortgage bonds - Outstanding mortgage bonds amounted to CHF 33.9 billion (EUR 21.1 billion) at the end of 1998, making mortgage bonds the second largest securities segment after confederate bonds (CHF 44.3 billion, EUR 27.6 billion). Mortgage bonds re-financed approximately 7% of the outstanding mortgage loans in 1998 and this proportion is likely to rise. New production in mortgage loans amounted to CHF 11.8 billion (EUR 7.3 billion) in 1998 and mortgage bonds outstanding rose by CHF 4.9 billion (EUR 3.1 billion). Hence 41.5% of new business was refinanced with mortgage bonds.
The rating of Swiss mortgage bonds is discussed at regular intervals, but has so far been put off as unnecessary. Without an official rating, the mortgage bond in Switzerland is classified as an AAA issuer, whereas abroad, with or without a rating, it is handicapped by the withholding tax (35% of the interest earned is withheld).
The mortgage bond act stipulates three requirement criteria, namely, "to arrange long-term mortgage loans at the most stable and lowest rate of interest possible for the property owner". In 1998 the mortgage bond institutes succeeded in convincing the Swiss Banking Commission, the EBK, the supervisory authority, that these requirements could best be met by a financing mix, whereby mortgage bonds with a duration of three to seven years at lower interest rates and those with a duration of eight to twelve years at slightly higher interest rates were issued. In a letter of November 1998 the EBK approved this system. Consequently mortgage bonds with a duration of three years or more can be issued.
MBS - The banks’ refinancing problem is worsening. Savers are increasingly investing their funds in bonds, shares and investment funds, with the result that deposit and current account balances and cash bonds at the banks are diminishing. Moreover, there are signs that the absorbing capacity of the Swiss capital market is inadequate to fully satisfy the increasing demand for loans. The two centralised mortgage bond issuing institutes are therefore working on the issuance of MBS. Interested member institutes are currently beginning to prepare their mortgages for certification (adapting mortgage contracts, training customer assistants, setting up IT facilities). An initial MBS issue could take place at the end of the year 2000 or in 2001. It will probably be on the euro market.
Furthermore, the two centralised mortgage bond issuing institutes are clarifying the issue of which functions they are permitted to undertake as part of an MBS transaction with the Swiss Banking Commission, the EBK. In particular, the mortgage bond institutions could provide the following services:
Equity backing of member banks of the mortgage bond institutes in relation to mortgage bond financing - The five main safety measures of the mortgage bond act are the following :
Hitherto the costs of the security measures in the mortgage bond system have remained low. However, with increasing sensitivity to the costs of equity, backing the financing of real estate loans using mortgage bonds is becoming a problem. The two mortgage bond institutes are working to relieve the equity requirements for their members.
Earlier text of the article contributed by European Mortgage Federation
The new legislation which is expected to be adopted soon is intended to update the mortgage bond and mortgage bank system in France. Reasons for reform are 1) the 1995 crisis of Crédit Foncier de France, 2) the introduction of the euro and 3) the desire on the part of the French authorities to stimulate the bond markets.
The new mortgage banks have the following characteristics:
In France, consumer protection laws which allow borrowers to repay their loans early. The mortgage banks will have to protect themselves against prepayment risk through overcollaterisation and by keeping more liquid assets in the pool.
The risk of the holding company should have no effect on the mortgage bank because of separation i.e. management of loans by the holding company. There will be a special supervisor (regulator) appointed from a list of legal auditors of banks.
The reform is a mid-term measure which will add another instrument to the funding of residential mortgage lending. Outstanding mortgage loans total FRF 2,300 billion. Of this, FRF 1,500 billion is sourced from regulated funding (of which FRF 400 billion is livret A of the savings banks and FRF 1,100 billion is from dedicated savings schemes i.e. épargne logements); the remainder, FRF 800 billion, is sourced from own funds, mortgage bonds, the Caisse de Refinancement Hypothécaire (CRH) and mortgage banks. The CRH is a central issuing institution which issues bonds on behalf of its members.
Owner occupation accounts for some 52% of the French market. To increase the use of funds from the unregulated savings sector, the authorities intend to clear up uncertainties for investors and encourage their interest in the market. The view is that at the beginning, the market will be limited to a small number of institutions including the Crédit Foncier de France and Dexia.
Argentaria's mortgage bond, Cédulas Hipotecarias (CH), was successfully launched at the start of 1999. In value it was EUR 1 billion with a ten year maturity listed in Luxembourg and Madrid. There was a difference in the credit rating of CH (Moody's Aa1) compared to the German Pfandbriefe primarily for two reasons 1) the different approaches of the different credit rating agencies and 2) the uncertainty on preferential rights of bond investors since bankruptcy law is unclear in Spain. If there is bankruptcy of a triple A issuer, the bondholder will receive payment but it is not sure when payment will be received and whether or not interest will be received. A risk weighting of 10%, according to article 11.2 of the Solvency Ratio Directive, is likely for the bond but the Spanish authorities have yet to transpose this into national law.
In determining valuation for loan purposes valuations have to be independent. Argentaria bonds are callable since the Spanish law allows borrowers to repay the mortgage early. If the borrower has a variable interest rate mortgage, there is a maximum early repayment penalty in the legislation of 1% of the outstanding loan. For a fixed interest rate mortgage there is no legislation on early repayment penalties. However, the government has recommended that the penalty should not exceed 2.5% when switching from a fixed interest rate mortgage to a variable interest rate mortgage. In practice, this recommendation has had a binding effect. For early repayment cases that are not covered above (variable or the switch from fixed to variable) the Bank of Spain has authorised a maximum repayment penalty of 5% for fixed interest rate loans.
There is no withholding tax in Spain for institutional investors - it is the opposite case for retail investors. Non-performing loans are defined as loans on which interest has not been paid for three months.
60% of the bonds were sold outside Spain (mostly investors from Germany, Italy and France). There was little demand from the UK and the Benelux. The issue was priced 10 basis points over bunds. There were benchmark problems with the issue as investors currently still refer to their national benchmarks. The prospectus provided was based on Spanish law.
Ireland has an owner occupation rate of 81%, the economy and mortgage lending have grown 10% and 27% respectively in the last year. In the last three years house prices in Ireland had increased by 134% on average. Currently 75% of funds for lending purposes are obtained via retail deposits. The Irish Mortgage and Savings Association has commissioned a report on 'Funding and Resources Growth in the context of EMU' (including an updated assessment of the role of mortgage bonds). It concluded that Irish lenders will not be able to continue to fund demand for loans through existing means (i.e. deposits). To meet future funding needs, new legislation needs to be drafted.
However, Ireland's consumer credit law applies to mortgage credit. With respect to early repayment there is no penalty for early repayment of a variable rate mortgage - the opposite is the case with a fixed rate mortgage.
Recently there has been a small increase in the price of callable bonds. There has been increased activity and euro denominated loans have been offered since 1st January 1999, initially to commercial customers and subsequently to retail customers. There has been some interest in euro loans (despite the currency risk) since the interest rate spread between the Danish kroner and the euro is some 50-70 basis points.
There is no mortgage bond market in Greece, but the Greek bond market has developed since 1997 with a ten year bond issued in 1997 and a fifteen year bond issued in 1998. However, the current tax environment is unfavourable to further development of the market. Government bonds are taxed at 10%, bank deposits at 15% and corporate bonds at 20%.
The issue of treasury bonds has decreased in volume and was EUR 11.1 billion euros in 1998. The issue of government bonds has increased - EUR 47.1 billion in 1996, EUR 59.1 billion in 1997 and EUR 66.1 billion in 1998. The expectation is that the mortgage bond will pick up although the current tax environment is unfavourable. The current interest rate for mortgage loans is 7.25%. This reflects the Greek government's policy to keep the drachma strong and the increasing likelihood that Greece will join the euro.
In Portugal the mortgage bond market is not significant. However, as a result of the decrease in the funds available from bank deposits, some banks are issuing mortgage bonds. Interest rates are similar to the euro zone. Typically, the interest rate on new loans is indexed to the EURIBOR with an additional margin of 2-3%.
In Austria there is a shrinking market for mortgage bonds with no net growth in mortgage or communal bonds. Margins have also shrunk. For the first time in 1998, bonds issued by Wohnbaubanken (= specialised institutions which fund housing) exceeded the volume of mortgage bonds. These bonds receive a favourable tax treatment as they are exempted from withholding tax. With respect to private customers there is a strong demand for Swiss franc loans despite the currency risk. This is also the case in Germany. With mortgage bonds in Austria there has been a complete shift to the euro. Issues are callable in Austria and there has been a considerable volume of redemptions especially by public authorities.
In non-euro zone member Sweden, the repo rate is approximately the same as the ECB rate.
In Sweden inflation is low, the budget is in balance and a budget surplus is expected over the next few years. With the surplus the government can reduce its debt and therefore bonds will be more attractive. The bond market is growing and in 1998 was in the order of 100 billion euros with 3 big issues of around the same size. House prices have increased 10% per annum on average with twice as many new dwellings as last year.
Legally the debate embraces deregulation versus more regulation and there will be legislation in the Autumn on securitisation. The government has to decide whether or not to allow a 50% weighting for commercial property loans. A government committee has proposed further liberalisation of the financial services sector namely:
In the UK there are no mortgage bonds but MBS are running at twice the level of last year. Abbey National issued a jumbo MBS of 1 billion sterling. Telephone and internet mortgages are a new feature of the marketplace and increased competition has resulted in lower margins. These factors have meant that mortgage providers are having to examine other sources of funding and they have tended to focus on MBS.
Finland is currently drafting new legislation on mortgage bonds.
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