Financial Market and Instruments

Case analysis Of Mortgage securitization in Hongkong and Asia

Submitted To:
Prof. Kulbir Singh

Submitted by:
Jay Devnani(2010082) Jitendra Bansal(2010087) Kushal Duggar(2010285) Raunak Patel(2010269)

Introduction:
In the given case John Lee a retail banker in Hong Kong want to take decision about the mortgage securities future That is it safe to invest in this business where this is a bit dicey as where this business will go and should they enter in this business or not.

What is Mortgage?
A legal agreement that conveys the conditional right ofownership on an asset or property by its owner (the mortgagor) to a lender (the mortgagee) as security for a loan. The lender's security interest is recorded in the register of title documents to make it public information, and is voided when the loan is repaid in full. Virtually any legally owned property can be mortgaged, although real property (land and buildings) are the most common. When personal property (appliances, cars, jewelry, etc.) is mortgaged, it is called a chattel mortgage. In case of equipment, real property, and vehicles, the right of possession and use of the mortgaged item normally remains with the mortgagor but (unless specifically prohibited in the mortgage agreement) the mortgagee has the right to take its possession (by following the prescribed procedure) at any time to protect his or her security interest.

What is securitization?
Securitisation" in its widest sense implies every such process which converts a financial relation into a transaction. Securitisation is the process of commoditisation. Securitisation is the process of integration and differentiation. Securitisation is the process of de-construction of an entity.

Securitization in Asia:
Lack of Credit Enhancements. Lack of investor confidence(lack of sophisticated foreign investors) Lack of Regulatory framework and other structural problems. Lack of Rationalization of Taxation Structure. Lack of Domestic long term bond market.

 Lack of Liquidity. For Hong Kong along with some issues listed above, lack of homogeneity of the MBS issues before HKMC resulted in an illiquid market.

Why a liquid debt market is important in a region?

Alternate source of funding for companies especially during time of crisis would release pressure of the Interbank market when they most need it. During the time of crisis when there is a capital flight an active debt market gives some avenues for banks to tap in to the local investors through raising local debt and issuing MBS in the local market . It helps in addressing the issue of asset liability mismatch.

The Hong Kong Mortgage Corporation

Incorporated as a public limited company in March 1997 and not as a statutory body. Modelled after Fannie Mae Wholly-owned by the HKSAR Government through the Exchange Fund Granted public sector entity status in July 1997 under the Banking Ordinance one of the 6 public sector entities, including MTRC, KCRC, Housing Authority, Hospital Authority and Airport Authority. The main functions of the HKMC were to purchase residential mortgage loans from banks for its retained portfolio and to fund its purchase through the issue of unsecured debt securities. It issued the Debt securities through Note Issuance Programme (NIP) OTC Stand-alone Retail Offering Debt Issuance Programme (DIP) Guaranteed Mortgage-Backed Pass-Through Securitisation Programme US$3 billion Mortgage-Backed Securitisation Programme (Bond Style)

Benefits for HKMC

Achieving its missions promote development of the MBS secondary mortgage market in Hong Kong through: Standardization of structure of MBS products and standardized legal documentation (HKMC acts as convenor of the Project on Standardization of Mortgage Origination Documents in Hong Kong) Providing a convenient, flexible and cost-efficient platform for issuing MBS Bond-style structure facilitates trading of MBS and hence enhance their liquidity in the secondary market. Funding Its a new funding source. To manage the credit, prepayment and Prime-HIBOR basis risks of HKMCs mortgage portfolio. Risk management

Benefits for investors (originators)

A convenient platform for securitisation For the Pass-Through Programme, banks may securitise part of their mortgage portfolios to meet their funding needs; to better manage the concentration and liquidity risks of their mortgage portfolios.

Alternative to mortgage loans Investing in the MBS as a supplement to originating mortgage primary market. Regulatory treatment 20% capital risk weighting of MBS vs. 50% weighting for mortgage loans MBS qualified as liquefiable assets under the Banking Ordinance loans in the

Programme versatility Flexible structure and extensive credit enhancement options to suit the investment/balance sheet management needs and risk appetite of investors different

 Efficiency of Programme Quicker and less costly for banks compared with issuance of MBS by

Benefits to Banks
Reduce cost of funding (Bankruptcy free structure ,credit rating, credit enhancement) To reduce capital requirements Diversification of funding source (compare the all in cost in both the bond market and ABS market to see which is cheaper, in our case compute the cost of funding for bank from the two sources) Diversification is beneficial in the time of crisis or difficult market condition as you have alternatives . Banks aim to optimize their funding among a mix of retail, interbank, and wholesale sources. Securitization has a key role to play in this mix . Generation of Fee income To increase ROA balance sheet capital management Risk management and credit risk transfer. (First loss tranche , transferring of NPAs) Accelerating earning for financial reporting purposes.

Conditions for a successful MBS Market

1) Continuous and sizable volume of Residential and Commercial Mortgages 2) Policy & Regulatory framework2) Improvement of Corporate Governance Regulatory and supervisory arrangementsTaxation policy, Legal protection Regulatory authority power

3) Market Infrastructure and liquidity Development of Long Term Bond markets

Lack of benchmark yield curve(Malaysia, Philippines) Limited supply of quality bonds Limited bond demand Inadequate bond infrastructure Market making and creation of secondary markets. 4) Incentive for investors Comparison with other sources of investment Favorable returns viza vizother traditional sources . MPF scheme authorities are looking for a quality paper to invest in. Huge capital flow from china expected.

Should the banks enter into it??

The benefits to the banks are explained in the previously, plus as established the market has a very high possibility of being successful. Minimization of Credit Risk exposure as the MBS is guaranteed by HKMC Release of regulatory capital by reducing risk-weightage from 50% to 20% Balance Sheet Management Tool Duration matching Minimum Liquefiable asset management(25% as ordered by HKMA)

Regular cash flows maintained by holding on to the notes. Maintain relationship with customers by the lieu of cross selling opportunities. Annual Servicing fee of 0.5% on the outstanding mortgage loans. MBS through HKMC quicker and cheaper.

The right time to enter the MBS market?

Hong Kong is in the middle of a Deflation and ongoing economic slump. Increased default risk so it makes sense to transfer it to HKMC. Interest rate deregulation increased pressure on deposit rate side.

The different risks of bank and HKMC?

Risk for HKMC Mortgage payment default Risk (Contagion Risk) increses in deflationary environment(Stringent covenants like LTV ratio of 70%) The fact that delinquency rates stayed below 2% even during the crisis and has remained relatively stable in the following years goes to show the stability of HK mortgage market. Loan Servicing Risk (Principal agent problem) Risk for Banks Counterparty risk Concentration of default risk with HKMC -increses in deflationary environment. Prepayment Risk (In this structure) Interest rate risk, Credit spread risk (In this structure) Liquidity Risk(In this structure)

Recommendations
A Fundamental understanding of securitization and its benefits is a key to thriving Asian securitization market. With the return of investor confidence after the crisis , provision of alternate source of funding becomes viable for which MBS is an instrument.

For HKMC Convince banks to go for securitization of existing mortgages (Pitch prepayment and default risk in a deflationary environment) Set up trenching For Banks In prevailing volatile market conditions enter into MBS to cap downside For Investors Given the potential of MBS market institutional and retail investors should consider MBS as a alternative asset class.