IV OECD Workshop on Housing Finance in Transition Economies Paris, December 14 th /15 th, 2004 Session 5: Development of Different Secondary Mortgage Markets and Instruments - Funding Instruments in the Region - Covered Bonds Tim Lassen, International Mortgage Banking Association of German Mortgage Banks
I. Covered Bond Market in Europe II. Covered Bond Legislation in Europe III. Segregation and Bankruptcy Remoteness of Cover Assets and of Covered Bonds 2
3 I. Covered Bond Market in Europe
Market Share of the European Covered Bond Countries in the European Covered Bond Market (end of 2003): 1.554 bn Spain 42,9 (2,76 %) Sweden 60,5 (3,89 %) Switzerland 30,9 (1,98 %) Luxembourg 16,7 (1,07 %) Ireland 13,5 (0,86 %) Austria 8,5 (0,54 %) Hungary 3,9 (0,25 %) Czech Republic 1,4 (0,09 %) Slovakia 0,3 (0,02 %) Poland 0,2 (0,01 %) Finland 0,065 (0,0042 %) Latvia 0,035 (0,0023 %) France 87,2 (5,6 %) Denmark 231,6 (14,89 %) Germany 1.056,7 (67,97 %) 4 (Source: EMF/VDH 22.11.2004) for comparison: UK covered bonds = 11 bn (09/2004 = 14 bn )
Public Covered Bonds in the EU, compared with Mortgage Covered Bonds (end of 2003, in bn.. EUR) 100,0% 90,0% Switzerland 30,9 (4,5%) Spain 42,9 (6,2%) France 53,7 (7,8%) Hungary 3,9 (0,6%) Austria 3,2 (0,5%) Czech Republic 1,4 (0,21%) Slovakia 0,287 (0,042%) Poland 0,178 (0,025%) Finland 0,065 (0,010%) Austria 5,3 (0,6%) Luxembourg 16,7 (1,9%) France 33,5 (3,9%) Ireland 13,5 (1,6%) 80,0% Sweden 60,5 (8,8%) Latvia 0,035 (0,005%)) 70,0% 60,0% 50,0% 40,0% 30,0% 20,0% Denmark 231,6 (33,7%) Germany 259,2 (37,7%) Germany 797,5 (92,0%) Latvia Finland Poland Slovakia Czech Rep. Austria Hungary Ireland Luxembourg Switzerland Spain France Sweden Denmark Germany 10,0% 0,0% Mortgage Covered Bonds Public Covered Bonds Total = 688,11 Total = 866,5 5 (Source: EMF/VDH -22.11.2004)
Pfandbriefe vs. Euroland Government Bonds (end of December 2003, bn )* Ireland Finland Portugal Austria Greece Netherlands Belgium Spain France Italy Germany Pfandbriefe 0 100 200 300 400 500 600 700 800 = fixed interest bullet redemption investment grade rated bonds with residual maturity of more than 1 year 6 * Source: Merrill Lynch Euro Broad Market Index
Funding of housing mortgage loans through mortgage bonds in EU- member states (end of 2002) 100 % 65 % 51 % 19 % 9 % 7 % Denmark Sweden Austria Germany Norway Spain 7 (source: European Mortgage Federation, Brussels)
Covered bonds outstanding in central Europe since 1996: Czech Republic,, Slovakia, Hungary, Poland, Latvia, Bulgaria, Lithuania as of 22.9.2004 4000 3500 3000 2500 2000 1500 1000 500 0 24 issues 1.750,19 Czech Republic 36 issues 585,83 69 issues 3.758,74 16 issues 240,96 10 issues 43,89 Volume of issues in mill. EUR (appr.) 7 issues 64,21 Exchange Rates: (as of 22.9.2004) 1 Euro = 31,71 CZK 245,38 HUF 38,89 SKK 4,56 PLN 0,66 LVL 3,45 LTL 1 issue 14,48 Slovakia Hungary Poland Latvia Bulgaria Lithuania 8
Outstanding covered bonds in % of GDP (end of 2003) 123,07% 75% 71,14% 49,65% 22,63% 10,23% 6,3% 5,77% 5,9% 5,6% 3,8% 2,26% 2,03% 0,9% 0,36% 0,36% 0,13% 0,046% 0,000093% DK LUX D S IRL H E CH F A CZ SK UK BG LV PL FIN LT 9 (source: Eurostat / VDH)
Importance of Art. 22 IV UCITS-Directive Covered bond as privileged investment instrument Investment funds Directive on life insurance companies Directive on large exposure credits Directive on capital adequacy Directive on deposit insurance European Central Bank funds may be invested in covered bonds according to Art. 22 IV UCITS: bound assets may be invested in covered bonds according to Art. 22 IV UCITS: covered bonds according to Art. 22 IV UCITS: covered bonds according to Art. 22 IV UCITS: covered bonds according to Art. 22 IV UCITS: covered bonds according to Art. 22 IV UCITS: 25% instead of 5-10% in securities of one issuer 40% instead of 5 % in securities of one issuer are not included in the calculation of the upper limit have to be covered only with half of the equity are excluded from the term of deposit eligible as collateral for loans granted by ECB and other central banks to banks - for covered bonds rating not necessary 10
Risk Weighting of covered bonds complying with Art. 63 (2) Consolidated Banking Directive 2000/12/EC (former Art. 11 II Solvency Ratio Directive), as of 10/2004 20% Italy Norway Portugal United Kingdom 10% Austria Belgium Denmark Finland France Germany Greece Ireland Luxembourg Netherlands Spain Sweden 11
II. Covered Bond Legislation in Europe 12
Geographical Overview - Covered Bond Legislation in Europe (as of Sept. 2004) Legislation in countries of the EU/EEA/CH 2000 19 2002 2005 2004 1998 2003 2003 Legislation in future EU member and further countries in transition 22 1990 2003 1999 1997 1995 1998 1995 1997 1999 2000 3 Concrete legislation in preparation Legislation under consideration 3 3 28 13
Important Differences of Covered Bond Regulations - valuation as basis of eligibility criteria for cover mortgages - Mortgage lending value 10 Market value 12 (including prudent market value) 14
Important Differences of Covered Bond Regulations - loan to value ratio as basis of eligibility criteria for cover mortgages - 60 % 8 70 % 3 OTHER / SEVERAL LTVs 11 15
Important Differences of Covered Bond Regulations - specialist bank principle - 4 basic models of specialisation of the issuer YES 12 NO 10 16
(1) French Model: covered bond issuer = totally specialised funding vehicle Finland, France, Ireland, Norway, partially Sweden holding bank Covered Bond Issuer holds only eligible assets staff all functions transfer of eligible assets administration through holding bank eligible assets issuer has status of a bank issue of covered bonds 17 as of 22.9.2004
(2) Specialised banks without/with non-eligible business Denmark, Germany (HBG), Hungary, Luxemburg, Poland, partially Sweden possibly holding bank / partner banks transfer of eligible assets possible: co-operation operation in distribution staff non-eligible assets eligible assets all functions issuer has the status of a bank issue of covered bonds own origination of eligible assets 18 as of 22.9.2004
(3) Universal bank with qualified covered bond license Germany (draft law), Latvia, Russia, Slovenia (draft law) universal bank qualified requirements for issuing covered bonds eligible assets issue of covered bonds own origination of eligible assets 19 as of 22.9.2004
(4) Right to issue covered bonds for all banks without license or with mandatory license, but without requirements to obtain the license Without license: Bulgaria, Czech Republic, Lithuania, Spain Mandatory license: Slovakia cover pool issue of covered bonds issuer has the status as a bank all banking activities, cover business included 20 as of 22.9.2004
Basic issues, which should be thought about, before making the decision d pro or contra specialization of the issuer of covered bonds: I. Supervision Issues Efficient and intensive supervision LTV limits for funding through covered bonds Security through institutional barriers or through over- collateralization II. Autonomous Risk Management Issues Responsibility for risk and asset/liabilities management Own risk awareness of the issuer Freedom of the issuer to decide, which assets to take into the cover pool Generating of assets by the issuer himself / only funding vehicle Dependency of a specialised issuer on mother bank 21
Basic issues, which should be thought about, before making the decision d pro or contra specialization of the issuer of covered bonds: III. Priority Issues "Ring fencing": Relation between covered bond creditors and unsecured creditors Possibility to place other creditors of the issuer at a disadvantage when starting to issue covered bonds (deposits, bonds with pari passu- or negative pledge-clauses) IV. Sustainability and Market Issues Diversification of products Avoidance of opportunistic issues - sustainable issues necessary Commitment to create and develop a covered bond market 22 V. Profitability Issues Costs for creating a specialised issuer Operational costs of originator and issuer Volume of eligible business in home country
III. Segregation and Bankruptcy Remoteness of Cover Assets and of Covered Bonds = pillar of security! 23
Questionnaire in order to check the level of segregation and bankruptcy remoteness of cover assets and of covered bonds: 1. What does covered mean? 2. How to identify the cover? 3. How to segregate/separate the cover from the bankruptcy estate? 4. Are covered bonds bankruptcy remote? 24
1. What does covered mean? purpose = transformation of cover assets into covered bonds (securitisation( securitisation) 25 cover assets covered bonds quality of assets management of - interest rate risks - liquidity risks - operational risks designation of cover assets to holders of covered bonds segregation of cover assets from originator s other assets in case of insolvency of originator bankruptcy remoteness of cover assets and covered bonds The less covered bond issuers are legally specialised,, the more and detailed regulations their covered bonds need in order to achieve clear segregation s and bankruptcy remoteness and to convince capital markets of it. timeliness of payment realistic?
2. How to identify the cover? (1) Which covered bond legislation prescribes special register? prerequisite for a clear and quick segregation of cover assets from bankruptcy estate possible YES 20 DK: implicit register NO 2 26 as of 22.9.2004
2. How to identify the cover? (2) - specialisation of the issuer and flexibility to create cover pools - flexibility to create cover pools Business constraints of the issuers no business constraints specialised institutions, special purpose vehicle non cover-eligible business allowed two-tiered structures but limited closely restricted no separate cover pool E N S E AYT 1 cover pool - only mortgages CZ RUS H CH 1 cover pool - mortgages + public sector assets LV S 2004 F 2 cover pools - mortgages - public sector assets A ÖPG SK D ÖPG D HBG A HBG LUX PL IRL FIN free grouping of cover pools DK N 2004 MBS True sale initiative in Germany 27 Big differences in legislation and supervisors rules regarding structure and administration of cover registers! as of 22.10.2004
3. How to segregate / separate the cover from the bankruptcy estate? (1) Questions: Any legal or administrative action necessary or automatically by law? Who administrates the cover assets? Who receives the cash flows on cover assets, when insolvency procedure is started over issuer? special cover pool administrator or bankruptcy administrator? 28
3. How to segregate / separate the cover from the bankruptcy estate? (2) Who administrates the cover assets? 6 special cover pool administrator 16 bankruptcy administrator 29 as of 22.9.2004
4. Are covered bonds bankruptcy remote? Questions: (1) Do covered bonds accelerate,, when the issuer goes in insolvency? (2) Will cover assets be legally part of the bankruptcy estate or form a legal separate estate (trust)? (3) How to ensure liquidity of the cover pool, when the issuer is bankrupt? (4) How to ensure timely payment for covered bonds? 30
4. (1) Do covered bonds accelerate, when the issuer goes in insolvency? Draft! 11 NO Do derivatives accelerate, which are part of the cover pool? (netting) NO = ok YES = problem 11 YES Do cover assets accelerate? cash flow for investor not foreseeable over whole maturity of covered bond YES NO 31 liquidity problems of the debtors/clients of the insolvent bank estate liquidity problems of the bankruptcy estate as of 22.9.2004
4. (2) Will cover assets be legally part of the bankruptcy estate or form a legal separate estate (trust)? Draft! When issuer is insolvent, cover assets are: legally separated (trust) part of insolvency estate, but holders of covered bonds have insolvency privilege 32 as of 22.9.2004
4. (3) Will cover assets be legally part of the bankruptcy estate or form a legal separate estate (trust)? - specialisation of the issuer and segregation of the cover pool from the issuer - Business constraints of the issuers specialised institutions, no business constraints special purpose vehicle two-tiered structures non cover-eligible business allowed segregation of cover pools limited but closely restricted no insolvency privilege N S insolvency privilege, but no cover pool E E AYT insolvency privilege + cover pool CZ SK RUS H F CH PL insolvency remoteness of cover pool detailed regulations reg. segregation procedure of cover pool LV D ÖPG D ÖPG 2004 D IRL S HBG 2004 LUX DK N 2004 D HBG 2004 FIN legal separation F MBS True sale initiative in Germany in respect to originator 33 as of 22.9.2004
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