A Heavenly Match - The Danish mortgage model in an international perspective. Jesper Berg Managing director, Nykredit Bank Iceland, July 1, 2014

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1 A Heavenly Match - The Danish mortgage model in an international perspective Jesper Berg Managing director, Nykredit Bank Iceland, July 1, 2014

2 Game Plan The Danish Mortgage model 1...makes sense in a financial stability perspective 2...is a crucial pillar in the financial system 3...build on simple principles 4...differs from other models in Europe 5...has performed well during the crisis 6...is part of the design of the Danish financial system 7...is challenged from EU regulations, but 2 1. juli 2014

3 Banking Balance Sheet of a (Simple) Bank Assets Liabilities Loans Liquid deposits Liquid assets Capital The role of banking in the economy involves, see for instance Freixas and Rochet (1997), transformation of assets In the maturity dimension, i.e. short deposits into long loans In the credit dimension monitoring loans This enhances economic efficiency and welfare but at the cost of inherently unstable banks => Liquidity and capital up

4 Banking The Danish Mortgage Model Assets Liabilities Loans Bonds Liquidity Capital Bonds can not be called by the investor (as can deposits) Payments on bonds match loans Borrowers pay cost of bond refinancing Borrowers are personally liable for their debt

5 The Quant perspective Danish financial balances (1) Financial balances 2012Q3 Billions DKK Percent of GDP Assets Liabilities Assets Liabilities Non-financial businesses % 305% Government % 69% Households % 151% MFI's % 408% Insurances and Pensions % 175% Central bank of Denmark % 33% Other Financial intermediaries % 120% Foreign sector % 272% Total % 1533% Source: Danmarks Nationalbank

6 The Quant Perspective Danish Financial balances (2) Financial balances 2012Q3 Percent of GDP MFI's Non-financial businesses Assets Liabilities Assets Liabilities Deposits 47% 158% 14% 0% Bonds 70% 187% 6% 10% Loans 278% 33% 19% 89% Shares and other equity 15% 23% 147% 194% Other 4% 7% 28% 11% Government Households Assets Liabilities Assets Liabilities Deposits 13% 1% 51% 0% Bonds 12% 52% 6% 1% Loans 14% 11% 0% 140% Shares and other equity 16% 0% 62% 0% Other 9% 6% 143% 10% Insurances and Pensions Danmarks Nationalbank Assets Liabilities Assets Liabilities Deposits 5% 0% 17% 19% Bonds 92% 0% 14% 10% Loans 2% 12% 1% 0% Shares and other equity 70% 12% 0% 4% Other 4% 150% 2% 0% Other Financial intermediaries Foreign sector Assets Liabilities Assets Liabilities Deposits 4% 3% 67% 38% Bonds 57% 0% 76% 74% Loans 6% 12% 28% 51% Shares and other equity 60% 102% 62% 98% Other 2% 1% 8% 11% Source: Danmarks Nationalbank

7 The Basics of the System Mortgage origination Mortgage deed Covered bond Mortgage proceeds Proceeds from bonds Borrower Mortgage bank Investor Payments Principal and interest payment Principal and interest payment Margin Reserve fund payment if in arrears 7

8 The Basics of the system - The Balance Principle Cash flow on the loan = cash flow on bonds issued to fund the loan Eliminates all financial risks for the issuer Borrower assumes price risk at refinancing (if any) Tap issuance Bonds issued daily to fund new loans = No pipeline risk Daily bond buybacks to match redeemed loans Issuer active as market maker, seller and buyer every day Price transparency Product transparency and standardisation All loan features embedded in the bonds 8

9 The Basics of the system - Complete Transparency for Borrowers Property address Title number Bond: Nykredit 5% Annuity 2019 Original loan amount = face value of bonds issued Debt (= bonds) outstanding Interest payment = bond coupon Principal payment Interest margin = 52 bp. p.a. 9 9

10 Months The Basics of the system Typical duration of a foreclosure procedure (in months) NL DK SE ES AT DE LU BE US FR GR PT IT Source: ECB & Nykredit 10 July 14

11 Loan types and bond types standardized across issuers Fixed Rate Mortgages Fixed rate callable annuity loans with or without interest-only periods Funded by fixed rate callable bonds DKK-denominated Maturities: 10, 15, 20 and 30 years With or without interest-only options (max 10 years) Bonds tapped daily depending on the lending activity Bonds open for issuance for 3 years to build up volume Adjustable Rate Mortgages Adjustable-rate annuity loans with or without interest only periods Funded by fixed rate non-callable bullet bonds DKK- or EUR-denominated Customer s interest lock in period equals bond maturity Daily tap issuance combined with auctions in March, September and December Bonds open for issuance until maturity Floating Rate Mortgages Capped or uncapped floating rate mortgage loans with or without interest only periods Funded by capped or uncapped floating rate bonds respectively Maturities: 5, 10, 20 and 30 years With or without interest-only options (max 10 years) Coupon based on CIBOR or EURIBOR Daily tap issuance combined with auctions in March, June September and December 11

12 Mortgage models come in more than 50 shades of grey juli 2014

13 Housing Finance Comparison juli 2014

14 Four objectives for a mortgage system Affordability The mortgage system should make it possible for households to acquire a home when they need it the most, i.e. early in an individual s productive life when income and savings are likely to be low Resilience towards falling property prices A fall in house prices should not put the financial system at risk Robustness during and after periods of financial stress Mortgage financing should be available at all points in time Government intervention should be minimal The mortgage system should not be dependent on government involvent such as guarantees, regulatory benefits or other subsidies juli 2014

15 Swap spreads for mortgage backed bonds FNMA 3,5% TBA NYKR 4%

16 Required OC and actual OC (S&P) % Actual CE 80 Target CE DK NO FI DE DK (B) SE FR NL BE IT UK PT IE ES (MCI) Note: MCI= Mortgage Credit Institution, B = Commercial bank Source: Standard & Poor s juli 2014

17 Actual CE Nominal (%) Actual CE Nominal vs. Target CE Nominal IT UK BE 200 ES DE FR 150 ES UK ES ES ES ES FR ES ES 100 FR ES IE UK ES FR FRFI FI NL 50 ES SE IT UK UK ES FR PT NODK SE FR FR FR SE DKNL FR NO DE BE UK SE DE FI DK DK DK DK SE DE DE DK DKDK DK DK DK DK DK DK 0 DK 0,00 20,00 40,00 60,00 80,00 100,00 120,00 Target CE Nominal (%) Source: Standard & Poor s DE DK ES FI FR IE IT NL NO PT SE UK juli 2014

18 Target CE Nominal (%) Relationship between asset-liability mismatch and required OC Weighted average ALM mismatch (years) Source: Standard & Poor s juli 2014

19 Housing Prices and Delinquencies Denmark % 5% 4% 3% 2% 1% 0% Single Family House Price Index; 1992Q1=100 << 3M arrears >> USA % 5% 4% 3% 2% 1% 0% FHFA House Price Index; 1980Q1=100 << Fannie Mae delinquncy rate >> 19 Source: DK: Association of Danish Mortgage Bank and Statistics Denmark USA: FHFA (Federal Housing Finance Agency) and Fannie Mae 19

20 Development in bid-ask spread during the crisis I

21 Development in bid-ask spread during the crisis II

22 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Issuance of European and Danish covered bonds and government guaranteed bank debt EURbn 80 Lehman Brothers Danish covered bonds European covered bonds GGBD

23 Mortgage Lending limited Credit Crunch YoY growth in mortgage lending and bank lending, sector excl MFI 30% 25% 20% 15% 10% 5% 0% -5% % -15% Total lending Mortgage lending Bank lending 23 Source: Danmarks Nationalbank, MFI statistics

24 Government Mortgage Market Support juli 2014

25 The Continental Model Savings MFI s Borrowers juli 2014

26 The US model Capital Markets Savings Borrowers MFI s juli 2014

27 The Danish Model Savings Pension + Life + OFI s Borrowers MFI s juli 2014

28 The Danish Mortgage Model Strong from birth but questionable fit into EU + Balance sheet structure + Originate to hold credit risk (Right to raise margin) + Outsource transparent financial risk (Balance principle) + Legal context (creditor friendly) + Performance -Neither Universal Bank nor capital markets structure -Regulatory risks (LCR, NSFR, BRRD, Large exposures.) -Ratings dependancy + Maybe paradigm for future EU system juli 2014

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