A Heavenly Match - The Danish mortgage model in an international perspective Jesper Berg Managing director, Nykredit Bank Iceland, July 1, 2014
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
Banking 101 - 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 3 01-07-2014
Banking 101 - 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 4 01-07-2014
The Quant perspective Danish financial balances (1) Financial balances 2012Q3 Billions DKK Percent of GDP Assets Liabilities Assets Liabilities Non-financial businesses 3.906 5.547 215% 305% Government 1.160 1.264 64% 69% Households 4.776 2.748 262% 151% MFI's 7.532 7.421 414% 408% Insurances and Pensions 3.173 3.177 174% 175% Central bank of Denmark 614 601 34% 33% Other Financial intermediaries 2.365 2.179 130% 120% Foreign sector 4.402 4.956 242% 272% Total 27.928 27.893 1535% 1533% Source: Danmarks Nationalbank 5 01-07-2014
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 6 01-07-2014
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
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
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
Months The Basics of the system Typical duration of a foreclosure procedure (in months) 60 50 40 30 20 10 0 NL DK SE ES AT DE LU BE US FR GR PT IT Source: ECB & Nykredit 10 July 14
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
Mortgage models come in more than 50 shades of grey 12 1. juli 2014
Housing Finance Comparison 13 1. juli 2014
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 14 1. juli 2014
Swap spreads for mortgage backed bonds 70 60 50 40 30 20 10 0 FNMA 3,5% TBA NYKR 4% 2041 15 01-07-2014
Required OC and actual OC (S&P) 180 160 140 120 100 % Actual CE 80 Target CE 60 40 20 0 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 16 1. juli 2014
Actual CE Nominal (%) Actual CE Nominal vs. Target CE Nominal 300 250 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 17 1. juli 2014
Target CE Nominal (%) Relationship between asset-liability mismatch and required OC 120 100 80 60 40 20 0-5 0 5 10 15 20 Weighted average ALM mismatch (years) Source: Standard & Poor s 18 1. juli 2014
Housing Prices and Delinquencies Denmark 400 300 200 100 0 1992 1995 1998 2001 2004 2007 2010 6% 5% 4% 3% 2% 1% 0% Single Family House Price Index; 1992Q1=100 << 3M arrears >> USA 400 300 200 100 0 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 6% 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
Development in bid-ask spread during the crisis I 20 01-07-2014
Development in bid-ask spread during the crisis II 21 01-07-2014
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 60 40 20 0 Danish covered bonds European covered bonds GGBD 22 01-07-2014
Mortgage Lending limited Credit Crunch YoY growth in mortgage lending and bank lending, sector excl MFI 30% 25% 20% 15% 10% 5% 0% -5% 2004 2005 2006 2007 2008 2009 2010-10% -15% Total lending Mortgage lending Bank lending 23 Source: Danmarks Nationalbank, MFI statistics
Government Mortgage Market Support 24 1. juli 2014
The Continental Model Savings MFI s Borrowers 25 1. juli 2014
The US model Capital Markets Savings Borrowers MFI s 26 1. juli 2014
The Danish Model Savings Pension + Life + OFI s Borrowers MFI s 27 1. juli 2014
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 28 1. juli 2014