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Developing Covered Mortgage Bond Markets Using the Danish System

Developing Covered Mortgage Bond Markets Using the Danish System . Presented at 15 th AMEDA Meeting, Fez, Morocco April 26, 2012 Steven Bernstein Managing Director, EMEA. VP and Soros – partnering around the world. Summit in 2001 - Prospect for Prosperity between Mexico and USA

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Developing Covered Mortgage Bond Markets Using the Danish System

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  1. Developing Covered Mortgage Bond Markets Using the Danish System Presented at 15th AMEDA Meeting, Fez, Morocco April 26, 2012 Steven Bernstein Managing Director, EMEA 15th AMEDA Conference

  2. VP and Soros – partnering around the world • Summit in 2001 - Prospect for Prosperity between Mexico and USA • Co-operation Federal Reserve – Soros • Contact between Soros Fund Management (SFM) and Danish Financial Sector in 2002 (Central Bank, Totalkredit and VP) • VP and SFM establishes Absalon in 2005 as a 50/50 % joint venture • Export of Danish mortgage solution to Mexico • HiTo is founded in Mexico in 2006 • The first loan was issued in Dec. 2007 • Other countries are interested… • Absalon Project founded in May 2010 • Worldwide activities....... 15th AMEDA Conference

  3. Mission • Work with financial institutions and regulators world wide in order to introduce the most stable funding model available for mortgage loans • Partner with local companies to install Absalon Project/VP systems • Work with mortgage lenders to develop quality mortgage origination programs though use of proper underwriting, servicing and funding systems • Work with regulators and legislators to develop sound mortgage banking laws 15th AMEDA Conference

  4. Why are we in business? • We are in business to provide stability and liquidity to international mortgage markets • Mortgage and housing markets are key drivers of economies • Other systems have proven unreliable (e.g., US pass-through MBS) • Help developing countries create mortgage finance markets 15th AMEDA Conference

  5. How we work - Inclusive • Partner with local companies to install Absalon Project/VP systems • Work with mortgage lenders to develop quality mortgage origination programs though use of proper underwriting, servicing and funding systems • Work with regulators and legislators to develop sound mortgage banking laws • Work with financial infrastructure providers (CSD’s, stock exchanges, central Banks etc.) to develop tight systems integration 15th AMEDA Conference

  6. Where we are working • Mexico: HiTo is our pilot company; securitizing mortgages since 2007 • South America • North America • Europe • Africa • Middle East 15th AMEDA Conference

  7. Western &Sharia Financial Systems • Absalon is designing systems for both Western as well as Islamic contracts and securities • Absalon is working with world leaders in Islamic finance as well as with top Islamic scholars in order to develop systems that produce and manage interest-free contracts and securities 15th AMEDA Conference

  8. The Danish Mortgage Model in brief …history, main principles and performance 15th AMEDA Conference

  9. VP Clearing & Custody Services Key Figures - 2010 Turnover – market value: • Bonds: EUR 4.725 billion • Shares: EUR 615 billion Daily turnover: • EUR 22.2 billion • 47.900 trades Securities on deposit (value): • EUR 825 billion Number of series: • Bonds: 2.449 series • Shares: 1.133 series Number of accounts: • 3,6 million The 3rd largest mortgage bond market worldwide - and 2nd in Europe 15th AMEDA Conference

  10. The fire in of 5 June 1795 • 25,000 people out of a population of 100,000 were made homeless • 941 buildings streets burned to the ground • Existing financial infrastructure unable to finance rebuilding of Copenhagen • First mortgage credit institution established in 1797 - ’Kreditkassen for HusejereiKøbenhavn’ • Owned by the bondholders • Loans callable by the lender • Bonds guaranteed by the King of Denmark • 1,132 new buildings completed in just 2 years 15th AMEDA Conference

  11. 1851: The new Mortgage Credit Associations • Mortgage Credit Associations pools borrowers • Diversifies event risk for lender/investor • Individual mortgage deeds vs. tradable mortgage bonds for lenders/investors • Association of borrowers • Uniform loan terms protects against predatory lending... • … and facilitated quick foreclosure proceedings and repossession of mortgaged property in case of default • Loans only callable by the borrower • Bond holders protected from risk • Capital reserves and maximum LTV of 60-80% of market value • Borrowers are jointly and severally liable • Balance principle protects against financial risks 15th AMEDA Conference

  12. Main characteristics in the Danish Mortgage Model • Principle of Balance (PoB) • Balances terms of loans and bonds • TAP issuance (series open for 3 years) • Pass through (no warehouse risk) • Prepayment Options • Prepayment (partial and full) • At par with cash • At market price by buying the bonds in the market (Investors carries market risk) • Responsible Lending • Originator services the loan throughout the lifetime of the loan • Originator carries credit risk • Transparency • Transparent price and cost structure • Bond prices public available on Stock Exchange • Liquid Bond Pools • Large bond series through TAP issuance in 3 years • Joint bond series for more MCI’s (Totalkredit model) • Voluntary Market Maker Agreement 15th AMEDA Conference

  13. Totalkredit Rating Agencies Regulators Information Repository Mortgage Insurance Market Bond Insurance Market 105 Banks (MCI’s) Investors Totalkredit (MSP) Borrowers VP Securities (CSD) NASDAQ OMX (XCH) Load adm. and advisory Systems System www • Capital market services • Issuance, registration of ownership, Clearing & settlement of Bonds • Liquid marketplace with transparent pricing • Long term and safe instrument • Product and Funding services • MCI services the loan • Originates the Loans and manage all legal and practical aspects of the processes • Loan Products (FRM, ARM, Interest only loans, etc) • DKK or EUR • Individual services • Borrower contact • Borrower and MCI liable for the loan • MCI issues First Loss Guanrantee 15th AMEDA Conference

  14. The Principle of Balance –link between loans and bonds • The balance principle – elimination of financial risks through pass-through securities Borrower Investor Principal & interest payment Interest, principal drawing Cover / Balance Mortgage bank No prepayment risk Margin Wages and admin. costs Fees & commissions Write-offs on mortgages Return on reserves Tax Results 15th AMEDA Conference

  15. Tap issuance • Bonds are issued in the secondary market on a daily basis • Market Maker solution • Prices are published daily through the Stock Exchange • A 30 year fixed rate bond is open for issuance: • In 3 years from it’s first opening date • As long as the price of the bond is below 100 • Meaning some bonds have a tenor of 33 years 15th AMEDA Conference

  16. Prepayment options – link between loans and bonds • Borrowers’ right to prepay, fully or partially, is embedded in one or two prepayment options exercisable during the entire term of the loan: • Callable loans have an embedded call option and delivery option • At par prices • At market price • Non callable loans have an embedded delivery option only 15th AMEDA Conference

  17. Transparency – link between loans and bonds • An implication of the Balance Principle is a link between loans and mortgage bonds issued to fund the loans • It is a long standing tradition to employ this link in: • the setting of loan terms • the pricing of loans to render the loan terms and the pricing fully transparent • Enable the borrower to check the loan terms and pricing based on available market information 15th AMEDA Conference

  18. Fully transparent: real time information 15th AMEDA Conference

  19. Responsible lending House Owner MCI Credit Risk Originator and Servicer End InvestorsInterest Risk • Mortgage Credit Institutions (MCIs) are required to retain credit riskand are responsible for special servicing of the loans • Bond investors only retain interest risk rather than credit and interest risk • MCIs can participate on equal terms, subject to rigorous regulatory requirements • MCIs act as “liability advisors” to homeowners, seeking to put their customers into the lowest risk adjusted cost loans AND seeking to take advantage of temporary dislocations in the bond market that may allow for an NPV gain for the borrower • Mortgage is funded by the issuance of standardized bonds • Bond market deals with familiar and hedgeable risks: level of rates, slope and curvature of yield curve, interest rate volatility, financing and counterparty selection 15th AMEDA Conference

  20. Stronglegal and practical framework • Exclusive rights - only authorised Mortgage Credit Institutions can issue mortgage bonds in Denmark • Supervision by the Danish FSA (Financial Supervisory Authority) • Lending - quality assets • Only mortgage loans against a registered collateral on real property • Restrictive requirements to valuation of properties • Maximum term of 30 years – but flexibility • LTV ratios - limits depending on property type (80% maximum) • Foreclosure procedure • 6-7 months from payment should be paid to compulsory date • Supported by the Danish Central Bank • Mortgage Bonds are automatically usable as collateral for getting liquidity (as REPOS) 15th AMEDA Conference

  21. The Danish Mortgage Credit Institutions • The basic principles has remained almost unchanged for 150 years, but: • No longer joint liability among borrowers • Balance principle modernised (Covered Bonds) • A very robust system, that has survived several crises • CrisisLoan loss • 1880s farm crisis Less than 1% • WW I - Denmark remained neutral No crisis • The great depression Less than 1% • WW II - Denmark occupied by Germany No crisis • Change in macro economic regime in 1980 and ’90s Less than 1% • Financial crisis 2008 Less than 1% …..and no losses at all for the investors! 15th AMEDA Conference

  22. Covered bonds for mortgages as percentage of GDP 2009 Source: European Covered Bond Council &Eurostat 15th AMEDA Conference

  23. Independent reviews of the Danish mortgage system • Moody’s: (2002) “Moody’s believes that Danish mortgage bonds are very strong and very low-risk financial instruments” • Mercer Oliver Wyman: (2003) “The Danish mortgage credit in a European context has high efficiency, low prices and large product offers” • Bank for International Settlements (BIS): (2004) “However, in the Danish case the institutional structure, the regulatory approach and monetary policy together have resulted in a market which, relative to the US market, has shown little or no stress in periods with significant refinancing” 15th AMEDA Conference

  24. Sample Project Road Map 2013 2011 2012 Aug Sep Jan Oct Nov Dec Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Initiate Project • Actions/results: • Present Initial Feasibility Study • Key stake holders agree to finance development of Business Plan • Company founded and Project organization agreed Feasibility Study Develop Business Plan • Actions/results: • Implementation requirements analysed and Operative Model and Business Model described • Revised Financial Analysis/Budget • Revised Time tables • Decision to go or no go taken • Company funded according to Business Plan or project closed implementation • Actions/results: • Organization built up • Implementation project takes place in NewCo and at external local partners like Stock Exchange/CSD • Marketing and Business Plans are implemented • Training and marketing material produced Integrated Test and training • Actions/results: • Integrated Test of the systems in NewCo • Integrated Test of the systems in interaction with other market systems • Training • Preparation for Go Live and production Go Live and Production • Actions/results: • Go Live • Business starts Project and quality management 15th AMEDA Conference

  25. Turnkey Solution Absalon offers an integrated turnkey solution • Absalon has teamed up with professional technology partners VP, Sopra andTotalkredit to develop a robust system • The system offered is based on the Danish Mortgage Model as implemented by Totalkreditin Denmark. • All IT related activities are handled by Absalon and technology partners • from software licenses, development, systems implementation & training, maintenance and support • to daily operations in VP Datacenters: a 24/7 managed operational environment in a 2 center environment, certified by 3 levels of IT audit (internal & external plus FSA) 15th AMEDA Conference

  26. Turnkey Solution MCI’s Mortgage Info Services (regulators/Borrovers/Investors/others) BORROWERS Primary Site (PROD) (services/SignOn) Internet Newco (services/SignOn) INVESTORS Secondary Site (TEST, DEMO) System to System Transactions CSD XCH 24/7 Systems Operations & TechnicalHelp Desk 15th AMEDA Conference

  27. Contact For more information please visit: www.absalonproject.com Or contact: Steve Bernstein Managing Director, EMEA sbernstein@absalonproject.com +32 471 25 24 54 15th AMEDA Conference

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