Developing Covered Mortgage Bond Markets Using the Danish System

15th AMEDA Conference 1

Developing Covered Mortgage Bond Markets Using the Danish System

Presented at 15th AMEDA Meeting, Fez, MoroccoApril 26, 2012

Steven Bernstein Managing Director, EMEA

April 26, 2012


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.......

April 26, 2012


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

April 26, 2012


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

April 26, 2012


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

April 26, 2012


Where we are working

• Mexico: HiTo is our pilot company; securitizing mortgages since 2007

• South America

• North America

• Europe

• Africa

• Middle East

April 26, 2012


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

April 26, 2012


The Danish Mortgage Model in brief

…history, main principles and performance

April 26, 2012


VP Clearing & Custody Services Key Figures - 2010Turnover – 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

April 26, 2012


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

April 26, 2012


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

April 26, 2012

15th AMEDA Conference12

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

April 26, 2012


Totalkredit

Totalkredit (MSP)

InformationRepository

Investors

MortgageInsurance

Market

BondInsurance

Market

RegulatorsRating Agencies

105 Banks (MCI’s)

Load adm. and advisory Systems System

www

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

Capital market services•Issuance, registration of ownership, Clearing & settlement of Bonds•Liquid marketplace with transparent pricing•Long term and safe instrument

NASDAQOMX(XCH)

Borrowers

Individual services•Borrower contact•Borrower and MCI liable for the loan•MCI issues First Loss Guanrantee

VPSecurities

(CSD)

April 26, 2012


The Principle of Balance –link between loans and bonds

– The balance principle – elimination of financial risks through pass-through securities

Principal & interest payment

Margin

Fees & commissions

Return on reserves

Interest, principal drawing

Wages and admin. costs

Write-offs on mortgages

TaxCover /Balance

Mortgage bank

Borrower Investor

Results

No prepayment risk

April 26, 2012

15th AMEDA Conference15

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

April 26, 2012


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

April 26, 2012


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

April 26, 2012

15th AMEDA Conference

Fully transparent: real time information

18April 26, 2012


Responsible lending

House OwnerMCI

Credit RiskOriginator and

Servicer

End InvestorsInterest Risk

1. 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

2. 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

April 26, 2012


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)

April 26, 2012


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!April 26, 2012


Covered bonds for mortgages as percentage of GDP

2009

Denmark Sweden Spain Ireland UK Germany France Netherlands0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

Source: European Covered Bond Council &Eurostat

April 26, 2012


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”

April 26, 2012


Sample Project Road Map

April 26, 2012

Sep AugJul Jun MayAprMarFebJanDec NovOct Sep AugJul Jun May

Project and quality management

Feasibility StudyDevelop Business Plan

implementation

Actions/results:•Present Initial Feasibility Study•Key stake holders agree to finance development of Business Plan•Company founded and Project organization agreed

AprMarFeb2011

Initiate Project

2012

Integrated Test and training

Go Live and Production

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

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

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

Actions/results:•Go Live•Business starts

JanDec NovOct Sep Aug2013


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)

April 26, 2012


Turnkey Solution

April 26, 2012

PrimarySite

(PROD)

SecondarySite

(TEST, DEMO)

Internet

24/7 Systems Operations &TechnicalHelp Desk

Newco

MCI’s

XCHCSD

BORROWERS

INVESTORS

(services/SignOn)

(services/SignOn)

System to SystemTransactions

Mortgage Info Services(regulators/Borrovers/Investors/others)


Contact

For more information please visit:

www.absalonproject.com

Or contact:

Steve Bernstein Managing Director, EMEA

[email protected]+32 471 25 24 54

April 26, 2012

mailto:[email protected]

Documents

Developing Covered Mortgage Bond Markets Using the Danish System