status of asset backed securities market and mortgage backed securities market in bulgaria financial...

8/11/2019 STATUS OF ASSET BACKED SECURITIES MARKET AND MORTGAGE BACKED SECURITIES MARKET IN BULGARIA FINAN

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STATUS OF ASSET BACKED SECURITIES MARKET AND MORTGAGE

BACKED SECURITIES MARKET IN BULGARIA

FINANCIAL &REGULATORY ASPECTS

Vineet Bhansali

Ali Yavar Amerjee

Ankita

Ankur Arora

Ayushi Singh

Geetika Singh

National Law University, Jodhpur (Batch of 2015), Semester IX

Working Paper Series

Faculty Advisor: Dr. Rituparna Das1

(Words: 15,247)

Abstract

This paper seeks to highlight the financial and regulatory aspects with respect to Assetbacked securities and Mortgage backed securities market in Bulgaria. It discusses the

viability, structure and framework of such instruments in light of the prevailing market

conditions and consumer preferences in Bulgaria. Further, it analyses the ABS and MBS

markets in other jurisdictions such as India and EU Countries as against Bulgaria. The

paper has dealt with several issues pertaining to securitization of these instruments and

the consequent advantages and disadvantages to the issuer and the market as such.

Lastly, it seeks to contribute to the government policy of Bulgaria for maintaining and

managing the ABS and MBS markets within the periphery of legal boundaries and the

banking regulations in the country.

1We hereby express our sincerest heartfelt gratitude to our faculty Dr. Rituparna Das for his guidance and

supervision. This paper has instilled in us a unique thirst for knowledge in the subject. It could not have

achieved completion without the aegis of Dr. Das.


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XXV.

REGULATORYTREATMENT..................................................................................................... 44

XXVI. RELIANCE ON CREDIT RATING AGENCIES........................................................................ 45

XXVII. TRANSPARENCY AND HARMONISATION........................................................................... 45

XXVIII. CONCLUSION........................................................................................................................ 46


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I. INTRODUCTION

MBS and ABS represent a major segment of the global capital markets. The process

of securitization of assets through MBS and ABS route, while complex, has got dominant

place in corporate finance and investment management because it can offer originators a

cheaper source of funding and investors a superior return. With the help of MBS and ABS, an

originator can transfer risk by transferring financial assets and convert illiquid assets into

tradable securities. The assets, once separated from the originator, are employed as backing

for securities. ABS and MBS offer alternative market-based financing, and other benefits like

improved hedging and risk management through diversification, credit enhancement,

enhanced balance sheet management and restructuring and efficient refinancing cost.2

Innovations and increasing complexity in MBS and ABS warrant a thorough understanding

of the nuances behind these securities.

A market for prudently designed ABS has the potential to improve the efficiency of resource

allocation in the economy and to allow for better risk sharing. It does so by transforming

relatively illiquid assets into more liquid securities. These can then be sold to investors

thereby allowing originators to obtain funding and, potentially, transfer part of the underlying

risk, while investors in such securities can diversify their portfolios in terms of risk and

return. This can lead to lower costs of capital, higher economic growth and a broaderdistribution of risk. A more diversified bank liability structure further tends to reduce the

dependency of banks lending decisions on business cycle conditions and to lower the

exposure of debtors to re-financing or liquidity risk, which increases banks resilience and

helps contain systemic risk. Securitization is also uniquely shaped to provide targeted funding

to a variety of economic activities, including by allowing lenders to match the profile of their

funding liabilities with those of the loans they have originated, and to address specific

investor preferences regarding the distribution of risk exposures. And high-quality/simple and

transparent senior ABS can in principle help meet the increasing demand for high-quality

collateral, providing a complement to government debt. Despite its long-term social value,

securitization today suffers from stigma, reflecting both its adverse reputation among

investors and conservatism among regulators and standard-setters. This is the consequence of

misaligned incentives in the years prior to the financial crisis, with many industry participants

2

Madhani, Pankaj M., Mortgage-Backed and Asset-Backed Securities - Concept and Lessons from SubprimeMarket (May 23, 2012). ICFAI University Press, 2009. Available at SSRN: http://ssrn.com/abstract=1965856.


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becoming entwined in a self-reinforcing dynamic between demand and supply of

securitizations.

The potential for securitization markets to damage financial stability was evidenced clearly

during the crisis. The Financial Stability Board (FSB) has adopted a two-pronged strategy

towards ensuring a more resilient shadow banking system, of which securitization markets

are a key building block. First, the FSB has developed a monitoring framework to enhance

national authorities ability to track developments in the shadow banking system with a view

to identifying the build-up of systemic risks and enabling corrective actions where necessary.

Second, the FSB has coordinated the development of policies in five areas where oversight

and regulation need to be strengthened to reduce systemic risks, including policies improving

transparency and aligning incentives in securitization.3

Official authorities ought to lend their

full support to a successful implementation of this strategy to ensure the benefits of

securitization are fully realized and that the market recovers in a form that adheres to

standards conducive to financial stability.

II. HISTORY OFABSAND MBSMARKET IN BULGARIA

Until 1989 it was only the State Savings Society that provided mortgage loans. The recipients

of loans were natural persons only and the bank financed the building and purchasing of housing,the acquiring of shares in real properties for the purpose of their complete buy-out, acquiring of

sites for building. In most cases it was the state or municipalities that were the sellers as they had

the legal obligation to build and sell homes to the population. The complete government control

over the process of building and sales of housing, the financing of the purchases and the return of

credits eliminated the danger of losses resulting from insolvency and abuse. During that period of

time the bank gained substantial experience with clients in mortgage loans made for the purpose of

buying homes. There were also considerable government subsidies expressed in writing off by thestate of part of the debt under certain conditions, crediting mostly long-term customers, etc. Interest

rates were very low (3 per cent simple annual interest). Loans could be paid back within 30 years.

After 1990 the state stopped subsidizing and facilitating natural persons in the purchase and

building of homes both as builder and seller and in terms of financial facilities. The DSK EAD

Bank kept its credit products on offer but the high inflation which resulted in extremely high

3

Strengthening Oversight and Regulation of Shadow Banking - An Overview of Policy Recommendationsand dated 29 August 2013.


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interest on such loans (reaching 300 per cent) reduced substantially demand in the credit market.

The financial stabilization after 1997 stabilized interest rates but the populations buying power was

already too low to bring back demand. The bank was no longer in a position to do long-term

planning and reduced the term of mortgage loans to 9 years. The reason for this can be found in the

structure of the deposits. These are mainly redeemable on sight and it is only thanks to its

empirical experience with non-depreciative remaining assets that the bank can afford to offer such

long-term loans. Following the adoption of the Banks and Credits Act in 1992 commercial banks in

Bulgaria became able to legally finance the commercial activity of businesses. This is actually the

larger mortgage market in the country.

It underwent the same stresses as the home mortgage market. This is generally a very short-term

market.4

The usual term of business mortgages is between 12 and 36 months. The reasons for this

are the banks inability to make long-term planning because of a changing economic environment

and the rather short term of the deposits used to finance crediting operations. Unfortunately,

Bulgarian National Bank does not require the banks which extend mortgage credits to report

separately on their volume. Additionally, the reporting requirements are being change almost every

year so it is impossible to give comparable data for the period 1995-1999. We can only outline the

development of the housing loans market and give data for 1999 and partially for 1998. Since the

beginning of 1998 (when a tendency towards macroeconomic stabilization was witnessed) thedemand for credits increased significantly. The individuals and firms were willing to take credits

although they knew that their property will be mortgaged in favour of the bank, the interest rate is

relatively high and the bank can increase it unilaterally (such clause is still included in the credit

contracts). On the other hand, as described above, the supply of credits in the Bulgarian banking

system is limited.5

Currently all housing credits are mortgage credits and no other form of housing financing is being

used. People who are not willing to mortgage their property usually gather money from relatives

and friends and/or use their own savings. The "monopolist" on the housing financing market is DSK

Bank. In 1998 outstanding residential mortgage credit in DSK Bank was 70,709,000 denominated

leva (about USD 42,214.328), which accounted for about 90% of the residential mortgage credit in

the whole banking sector.

4Balzs Horvth and Istvn P. Szkely, The Role of Medium-Term Fiscal Frameworks for Transition Countries:

The Case of Bulgaria, Emerging Markets Finance & Trade, Vol. 39, No. 1, The Role of Fiscal Reforms in the

Transition (Jan. - Feb., 2003), pp. 86-113.5Ibid.


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The other very active player on the market is Bulgarian - American Credit Bank. The volume of

housing loans extended by other banks is negligible

III. FRAMEWORKIn Bulgaria, the legal basis for the issue of covered bonds is the Mortgage-backed Bonds

Law issued by 38th National Assembly on 27 September 2000, published in the State Gazette

(Darzhaven vestnik) issue 83 of 10 October 20001.6Ordinance No 8 of Bulgarian National Bank on

the Capital Adequacy of Credit Institutions treats the risk weighting of other types of covered

bonds.

A. Mortgage-backed bonds

Mortgage-backed bonds shall be securities issued by banks on the basis of their loan

portfolio and secured by one or more first mortgages on real estate in favour of banks

(mortgage loans).(2) The real estate under paragraph 1 shall be insured against destruction

and may be of the following types:

1. housing units, including leased out;

2. villas, seasonal and holiday housing;

3. commercial and administrative office space, hotels, restaurants and other similar real

estate;

4. industrial and warehousing premises.7

B. Mortgage Bonds Collateral

Mortgage bonds collateral are mortgage credits /main collateral/ or assets with zero risk

weight in accordance with the classification set in a regulation of BNB /substitute collateral/. The

substitute collateral should not exceed 30 per cent of the issuing bank's liabilities on the outstanding

6Amended; issue 59 of 2006; in force on the date of entry into force of the Treaty of Accession of the Republic

of Bulgaria to the European Union; amended; issues 52 and 59 of 2007; amended; issue 24 of 2009; effective as

of 31 March 2009

7Law on Mortgage-backed Bonds(Issued by the 38th National Assembly on 27 September 2000; published in

the Darjaven Vestnik, issue 83 of 10 October 2000; amended; issue 59 of 2006; in force on the date of entry into

force of the Treaty of Accession of the Republic of Bulgaria to the European Union; amended; issues 52 and 59of 2007; amended; issue 24 of 2009; effective as of 31 March 2009)


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mortgage bonds. Mortgage loans are used as collateral up to 60-80% of the mortgage appraisal

value of the real property (the exact per cent depends on the type of the property).

The purpose of these limitations is the collateral risk minimization. The credits are used as collateral

at a value lower than the mortgage appraisal value. The main collateral/substitute collateral ratio

requires a better management of the maturity structure of the bank's claims on mortgage loans and

the liabilities on mortgage bonds in terms of decreasing the risk evolving from the temporary

misbalances in cash flows and worsened liquidity.8The law envisages that mortgage bonds will be

issued under the existing legislation.9Additional requirements are set to the prospectus/the offer to

subscribe to the issue including internal rules of the issuing bank as well as the main characteristics

of the collateral portfolio.

IV. STRUCTURE OFTHE ISSUER

Pursuant to the Mortgage-backed Bonds Law, the mortgage-backed bonds shall be securities

issued by banks on the basis of their loan portfolio and secured by one or more first in rank

mortgages on real estate in favour of banks (mortgage loans).10Only banks may issue bonds called

mortgage-backed bonds. The real estate under the previous paragraph shall be insured against

destruction and shall be of the following types:

Housing units, including leased out;

Villas, seasonal and holiday housing

Commercial and administrative office spaces, hotels, restaurants and other similar real estate;

and

Industrial and warehousing premises.

The issuing bank shall adopt internal rules on conducting and documenting mortgage appraisals of

real estate which shall comply with the requirements of Article 73, paragraph 4 of the BulgarianLaw on Credit Institutions. Securities issued under procedures other than the one laid down by the

Mortgage-backed Bonds Law may not referred to with, or include in their appellation, the extension

mortgage-backed bond, or any combination of these words.

8Mortgage Financing in Bulgaria:Developments, Housing Market and General Backgroundi, Tzveta Dimitrova,

IMEDaniela Vladimirova, DSK BankDr. Krassen Stanchev, IME (editor)Martim Dimitrov, IME.

9 Alexandru Minea and Christophe Rault, Some New Insights into Monetary Transmission Mechanism in

Bulgaria, Journal of Economic Integration, Vol. 24, No. 3 (September 2009), pp. 563-595.10

Ibid.


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V. COVERASSETS

The outstanding mortgagebacked bonds shall be covered by mortgage loans of the issuing

bank (principal cover). To substitute loans from the principal cover that have been repaid in full or

in part, the issuing bank may include the following of its assets in the cover of mortgage-backed

bonds (substitution cover):

Cash or funds on account with the Bulgarian National Bank (BNB) and/or commercial banks;

Claims on the Government of the Republic of Bulgaria or the Bulgarian National Bank, and

claims fully secured by them;

Claims on governments or central banks of states as determined by the Bulgarian National Bank;

Claims on international institutions as determined by the Bulgarian National Bank;

Claims fully backed by government securities issued by the Government of the Republic of

Bulgaria;

Bulgarian National Bank, the Governments, Central Banks or international institutions;

Claims secured by gold; and

Claims fully backed by bank deposits denominated in Bulgarian levs or in a foreign currency for

which the BNB quotes daily a central exchange rate.

The substitution cover of mortgage-backed securities shall not exceed 30% of the total amount of

liabilities of the issuing bank under that issue. Mortgage-backed Bonds cover from any issue (the

sum total of the principal cover and the substitution cover) may not be less than the total amount of

liabilities towards the principals of mortgage-backed bonds from that issue which are outstanding

and in circulation outside the issuing bank. The claims of the bondholders under mortgage-backed

bonds from each issue shall be secured by a first pledge on the assets of the issuing bank included in

the cover of that issue. The pledge is a subject of entrance in the Central Registers of Special

Pledges, with the respective issue of mortgage-backed bonds being indicated as a pledge creditor.

The issuing bank shall request an entry and submit to the Central Register of Special Pledges all

data required for the entry of the pledge within one month after executing a mortgage-backed bonds

issue and shall update that data at least once every six months thereafter. The pledge shall remain in

force until the full redemption of the liabilities of the issuing bank under the respective issue of

mortgage-backed bonds without the need for any renewal. Deletion of the pledge entry shall be


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made upon the full redemption of the issuing banks liabilities under the respective issue of

mortgage-backed bonds on the basis of a document issued by the banks auditors.11

VI. COLLATERAL REGISTERThe issuing bank is obliged to keep a register of the issued mortgage bonds collateral. The

bank constitutes a special pledge1 on the claims stemming from the credits included in the register.

The register includes different pools of credits used as collateral for separate mortgage bonds issues.

The access to the register is set in bank's internal regulations, which do not insult the bank secret.

The bank is obliged to manage and report separately the assets included in the collateral register and

may not impose any other burdens on them. The purpose of these regulations is to secure the claims

of the mortgage bonds creditors and to assure them accurate information for the collateral's

composition and its quality. The separate reporting of the collateral isolates these assets of the bank

from the others and decreases this portfolio's risk for it is composed of claims with lower risk

(collateralized with a real property).

VII. PREFERENTIAL CLAIM ON COLLATERALASSETS IN CASE OF INSOLVENCY

The draft law sets preferential regime for claims of mortgage bonds creditors in accordance

with the usual European practice. In case of insolvency of the issuer the claims on credits included

in the collateral register are separated from the common assets of the bank. A trustee, appointed by

the courts, separately manages these claims. He or she acts simultaneously to the assignee that is

appointed by the court in case of insolvency of the bank. The trustee has the rights and obligations

of the assignee in respect of the assets included in the collateral register. The law does not change in

any way the existing legislation in respect of the mortgage regime, the regulations of the Bulgarian

National Bank or the common order of bond issuing .Moreover, the creation of this instrument

known for more than 200 years in the European practice is possible because of the good regulation

of mortgages and the application of supervisory requirements which are unified with EU standards.

The purpose of the law is the minimization of risks born by the banks in their credit activity and

respectively risks born by bond creditors as well as decreasing costs of mortgage financing and

11Adopted by the Bulgarian National Bank, published in the Darjaven Vestnik, issue 106 of 27 December 2006,

in force as of 1 January 2007; amended, issue 62 of 2007; amended, issue 38 of 2008, effective as of 11April

2008; amended, issue 21 of 2009; amended, issues 20, 85 and 102 of 2010; amended, issue 95 of 2011(http://www.bnb.bg/bnbweb/groups/public/documents/bnb_law/regulations_8_credit_instit_en.pdf).


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allowing easy access to mortgage credits as a long-term source of financing for a broader range of

people and companies.12

VIII. LEGAL REGULATION OF BONDS AS SECURITIESBonds are regulated by the Commerce Act and the Public Offering of Securities Act and are

subject to obligations and material law. Under the law, securities are transferable rights or

documents, which materialize transferable rights. The Commerce Act does not provide a definition

of bonds but its characteristics can be deducted from the texts of this law:

The bond as a security materializes the right to receive principal and interest.

The bond may be backed by funds available or not. When it is backed by property it

gives rise to both an obligation and a material legal relationship: the right of

ownership of its holder.

The bond may be issued to bearer or to a named individual.

The bonds issued by a company may have various face values.

The Commerce Act provides regulation of the general requirements in respect to the

issuer which make him eligible to issue bonds. Of all commercial companies, only the

joint stock company can issue bonds. There are requirements in respect to the amount

of the companys capital and the volume of the bonds as a percentage of the

companys own capital.

Exceptions can also be made for issues guaranteed by the state or by banks (under the

Commerce Act) and such issued by banks (the Banks Act).

The history of the company. At least two annual accounting reports approved by the

general meeting are required.

The manner of resolving to issue bonds.13

12 Mortgage Financing in Bulgaria:Developments, Housing Market and General Backgroundi, Tzveta

Dimitrova, IMEDaniela Vladimirova, DSK BankDr. Krassen Stanchev, IME (editor)Martim Dimitrov, IME.13

Ibid.


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IX. VALUATIONAND LTVCRITERIA

A. Valuation

Mortgage appraisals of property shall be performed by officers of the issuing bank or by

physical persons designated by it having the relevant qualifications and experience. For appraisals

of the property the comparative method, the revenue method and the cost-to-make method shall be

used for the purposes of the law. The mortgage appraisal shall explicitly specify the method or

combination of the above methods used with the relative weight of each method in the appraisal, as

well as the sources of data used in the analysis and calculations.

Subsequent mortgage appraisals of property used as collateral on the loans recorded in the register

of mortgage- backed bonds cover shall be made at least once every twelve months for loans which:

Have outstanding liabilities exceeding 1% of the issuing banks own funds; or

Have not been consistently classified as standard risk exposures throughout that period.

B. LTV criteri a

LTV criteria are generally defined in the banksown lending policies depending on their risk

appetite and other internal rules.14No specific legal requirements are imposed by the local banking

law.

X. ASSET BACKEDAND MORTGAGE BACKED SECURITIES INTHE EUROPEAN UNION:

ACOMPARATIVEANALYSIS

A. The European ABS market: evoluti on and current size

The Asset backed security (ABS) market peaked in Europe before the sub-prime

crisis, with a total of $1.2 trillion in new ABS issuance in 2008. By 2013, total new issuance

was only $239 billion (Figure 1).15Demand for these assets plummeted after 2008 because of

the deterioration in the rating of the collateral behind the various types of ABS, leading to a

major market price correction of ABS products.

14 Balzs Horvth and Istvn P. Szkely, The Role of Medium-Term Fiscal Frameworks for Transition

Countries: The Case of Bulgaria, Emerging Markets Finance & Trade, Vol. 39, No. 1, The Role of Fiscal

Reforms in the Transition (Jan. - Feb., 2003), pp. 86-113.

15 Carlo Altomonte & Patrizia Bussoli, Asset-backed securities: The key to unlocking Europe's credit

markets?, BRUEGEL, July 24, 2014, available at http://www.bruegel.org/publications/publication-detail/publication/842-asset-backed-securities-the-key-to-unlocking-europes-credit-markets/


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Figure 1: New issuance in the EU ABS market, 1999-2013 (2014Q2)

Source:SIFMA (July 2014).

Moreover, the freeze in European inter-bank lending reduced demand for these assets as

collateral for repurchase (repo) agreements (in other words, agreement to sell an asset and

buy it back at a later date).16In particular, after the start of the financial crisis in 2007-08, the

ECB progressively tightened the rating and structural requirements for ABS it would accept

as repo collateral, with the result that using ABS as repo collateral became expensive, in

particular compared to covered bonds. Hence, after 2008, the amount of eligible ABS

declined by 38 percent while covered bonds increased by 14 percent, until in mid-2012

covered bonds overtook ABS as delivered repo collateral for the first time since 2007.17

A final blow to the ABS market during the crisis came from the insurance sector. Insurance

funds, traditionally large buyers of ABS products, were also negatively impacted by the

introduction of more restrictive regulation in response to the crisis, and consequently limited

their ABS purchases.18

Country-by-country, the smallest players in the market (eg Belgium and Ireland) saw a

decrease in new issuance of more than 95 percent from the peak, while, among the main

issuers, new issuance in Italy, the Netherlands and Spain dropped by about 73 percent. In

Germany, the decline was 80 percent.19It is interesting to look at the United Kingdom: here,

16Id.

17Id.

18

Id.19

Id.


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new issuance represented almost a third of total European issuance on average until 2008, but

after the peak, UK flows dropped by 90 percent, with new issuance in 2013 representing less

than 20 percent of the European total. Considering this change in the UKs role in the

structured product market, new issuance in the euro area rose to 73 percent of total European

new issuance in 2013, from 63 percent in 2008. However, in volume terms, euro-area

issuance was slashed from $766 billion to $175 billion.

Interestingly, the collateral behind the ABS products also varied during the crisis, with the

collapse in the issuance of Real Mortgage Backed Securities (RMBS) and European

Collateralised Debt Obligations (CDOs), with issuance of both dropping by 90 percent

between 2008 and 2013 (Figure 2). The composition of overall issuance thus changed, with a

(relative) increase in ABS with consumer credit as collateral, and a marginal increase in ABS

backed by loans to small and medium-sized enterprises.

Figure 2: Breakdown of ABS issuance per type of collateral, various years


Another indication of the reduction in the liquidity of this product is the amount of new

issuance placed on the market relative to ABS retained by originators, such as banks that

package securitised products (Figure 3). Before the crisis, almost 70 percent of new issuance

was placed on the market, and the remainder retained by originators. After 2008, the share of

new issuance placed on the market dropped to below 10 percent, signalling virtual market


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refusal of these securities. More recent figures point to a market placement rate of about 40

percent, though at much lower overall volumes.20

Figure 3: Retention rate of ABS products, various years and type of collateral


However, originator retention rates vary by type of instrument. Despite the dramatic

reduction in issuance of CDO and Commercial Mortgage Backed Securities (CMBS),

currently around 90 percent of their new issuance is placed on the market, probably because

of demand from specialised investors, who could no longer find these securities on the

market. By contrast, there is weaker market demand for RMBS, generic ABS (car loans,

leases, etc) and SME ABS. In particular, almost all new SME ABS are retained on banks

balance sheets, with only 10 percent placed on the market.

B. Potenti al f or i ncrease in size

The outstanding amount of European securitisation, at the end of 2013, was

approximately 1 trillion, of which roughly half was placed on the market (Table 1 on the

next page). For comparison, at its peak in 2008, the overall outstanding amount of the ABS

market reached more than 2.2 trillion. About 60 percent of the market (637 billion) is made

up of mortgage-backed securities (residential and commercial), followed by standard ABS

(car loans, leases, etc) with a volume of 150 billion, and SME ABS for 102 billion. CDOs

stood at 113 billion.21

20

Id.21

Id.


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Table 1: Total outstanding amount of EU securitised products

Source:SIFMA data Q1-2014.

The quality of these securities varies in terms of collateral type, with about 77 percent of the

amount outstanding rated above BBB, and therefore eligible for collateral transactions with

the ECB3 (Figure 4). The highest presence of high-rated securities is in France and Germany,

while Italian and Spanish ABS are more concentrated in the single A category, in line with

the evolution of the sovereign ratings in these countries. In terms of collateral type, SME

ABS are the lowest quality, probably due to the heterogeneity of the collateral and the

deterioration of companies balance sheets during the crisis. Moreover, in the case of SMEs

the quality of financial information reported in balance sheets is in general less regular and

accurate, an issue that also impacts negatively on the rating, because it implies a more

negative assessment of the probability that loans will be repaid. From 30 to 40 percent of

SME ABS are currently estimated to be sub-investment grade or not rated. Italy and Spain are

also the countries with the main outstanding volumes of SME ABS.


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Figure 4: Rating of ABS products per type of collateral and country, 2013

Source:SIFMA

Given these figures, what potential for growth does the ABS market have overall, on the

basis that potential ECB purchases could create sufficient demand to revitalise the market?

Looking at the markets for collateral, data from monetary financial institutions shows (Figure

5) that the outstanding amount of mortgages for house purchases (thus secured lending)

stabilised at about 3.8 trillion in 2013 in the euro area, while the outstanding amount of bank

loans to non-financial corporations (NFC) in the euro area reached about 4.2 trillion. Figure

5 also compares the trend in the mortgage market to that in the RMBS market (left panel),

and NFC loans to SME ABS (right panel).

In both cases, there has been an evident fall in volumes of both types of securitised product,

with SME ABS performing relatively worse. The reason is the contraction of credit demand


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coupled with bank deleveraging, leading to a contraction of NFC loans, compared to relative

stability in the volume of mortgage loans outstanding. Hence, collateral for SME ABS

operations has been squeezed relatively more compared to RMBS. Moreover, one has to

consider the negative regulatory impact on capital requirements associated with the issuance

of this type of product.

The question is, then, how much of these outstanding volumes of loans to NFCs or mortgage

loans worth 8 trillion could be translated into new issuance of RMBS and SME ABS. In line

with Batchvarov (2014), we make estimates on the basis of mortgage loans to households and

loans to non-financial corporations, for the countries that represent 80 percent of the total

portfolio of outstanding loans in the euro area (Germany, France, Italy, Spain, Ireland and

Portugal). The share of SME loans in total NFC loans, as estimated by the OECD (2013),

varies between these countries. Applying these shares to the euro area, the implied euro-area

SME ABS share is approximately 25 percent of total outstanding NFC loans.

On the basis of the conservative assumption that only 50 percent of the 8 trillion of existing

loans is ultimately eligible for securitisation (eg for reasons of maturity or loan

characteristics), we then introduce a different haircut so that the securitised products attain an

investment grade rating (to be eligible as a collateral for the ECB). Unlike the standard

assumption of a homogeneous 10 percent haircut for subordination for all categories of assets

(Batchvarov, 2014), we apply a more prudential and differentiated haircut for the three main

categories of assets selected, as retrieved from updated statistics for these securities

(SIFMA): 35 percent for SMEs loans, 30 percent for ABS backed by loans to large

corporations, and 15 percent for mortgages.

Based on this, we estimate a maximum amount of securitisation of roughly 3 trillion

(compared to 4 trillion estimated by Batchvarov, 2014), broken down as shown by Figure 6

on the next page. It should be noted that SME ABS would represent the smallest fraction

(about 10 percent) of this market.


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Figure 6: Estimates of potential ABS market for the euro area ( billions)

Source:Bruegel.

Table 2 on the next page shows that the estimated breakdown of the potential overall ABS

market by country will vary according to the size and composition of each countrys

underlying market for collateral5: Germany, France and Italy would each represent almost 20

percent of the total NFC-loan ABS, while in terms of SME ABS, Spain would count for a

fifth of the whole amount, with Germany and France accounting for about 17 percent each.

The role of Germany is also significant in the RMBS market, representing about 26 percent

of the outstanding amount, followed by France, Spain and Italy.


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Table 2: Potential availability of ABS per country (%)

Source:Bruegel estimates based on MFI data (March 2014) and OECD

C. The revival of the ABS market: options

Our estimates show that the euro-area securitisation market has the potential to build

significant volume and to be sufficiently liquid for use in possible non-conventional monetary

operations. However, a number of trade-offs must be considered relating to the timing of

ABS market measures, and the underlying size of the market at that moment: the earlier that

measures are taken, the more restricted will be the type of ABS product that can be targeted

for direct purchase (eg SME ABS only), reducing the impact of potential ECB operations on

credit markets.

These trade-offs arise because the current securitised products on the market differ in terms

of underlying characteristics, ie collateral type and thus rating, borrowers quality and

geographic distribution, loans residual maturity, frequency of repayment, cost ofcredit, type

and amount of interest (fixed or variable), prepayment rates and possible credit enhancements

built into the structure6. Because of these heterogeneous characteristics, only a fraction of

existing ABS products are ready to use, if ever, by the ECB. Moreover, within the existing

range of products, there are different implications of the ECB targeting for direct purchase

only SME ABS rather than RMBS. Undertaking specific regulatory steps aimed at

standardising the characteristics of securitised products in different countries might allow the


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21

full activation of the estimated 3 trillion in potential ABS market volume, but reaching such

a figure would require time for implementation.

In the following sections we detail the ECBs options.

Option 1: Act small and fast

Option 1 would involve the direct purchase of very simple (plain vanilla) existing

ABS products with corporate credit exposure7. By pursuing this option, the ECB could act

immediately, but would have a limited direct impact on credit markets. Existing ABS

products limited to SMEs loans amount to 102 billion (Table 1). If the lease component of

generic ABS is included, one could add a further 15 billion. With respect to these figures,

the volume of securitised products available for immediate use with a rating aboveinvestment grade is 60 percent of SMEs ABS and 50 percent of the lease components. As a

result, with these constraints, the maximum theoretical size of the ABS market for immediate

ECB intervention is about 68 billion. This is probably not enough to generate a direct impact

on credit conditions in the euro area.

This does not imply, however, that there is no role for an ABS market backed only by

corporate

Option 2: Act large and slow

Option 2 essentially implies reviving, deepening and integrating the euro-area ABS

market so it can be used as a new tool for non-conventional monetary policy. The ECB and

the Bank of England (2014b) point at improving the regulatory environment for ABS

products to better differentiate the necessary prudential requirements for relatively simple,

robust and transparent ABS products (eg consumer finance ABS, RMBS and SME ABS)

from more complex and potentially illiquid instruments. By revamping this market, these

instruments could be used effectively as a direct vehicle through which non-conventional

monetary operations could be run. Clearly, the trade-off here is that developing the latter

would require a number of changes to underlying regulation, and would thus take time.

To achieve a high-quality, simple and transparent European ABS product, two areas of

regulatory change should be developed: one on collateral rules, for the corporate loan market

in particular; the other on ABS product characteristics, ie the format to be applied to various

types of ABS10.


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22

D. ABS product character istics

Two issues also need to be addressed in terms of the format of securities:

Common guidelines on ABS structure

The risks of ABS are embedded not only in the type of underlying collateral that is

securitised, but also in the way collateral is sliced and packaged (see Box 1 for an overview

of the basic elements constituting an ABS product).

A common structure for each type of collateral would ease the origination process and imply

that the spread between different bonds in each rating category would depend only on

differences between collateral characteristics (such as geographical distribution, maturity or

the legal framework applying to default). Common structure could tremendously boost

market liquidity. Also, the cost of creating the instruments should decrease, as pan-European

banks will be able to leverage the size of their loan pool across European markets. With a

common structure, the rating framework should become more homogeneous as well, cutting

the cost of providing ratings and making the European ABS market much more similar to the

US market. Ratings will become more closely related to collateral characteristics and less to

the sovereign rating of the originator, and monitoring by rating agencies during the life of the

product will focus more on collateral evolution. A straightforward way of achieving this

result would be to build on the idea, already hinted at by the ECB, that only an ABS format

with a plain vanilla structure would be eligible for purchase by the ECB.

Common guidelines on the setup of SPVs within national borders

Another key factor in the underlying heterogeneity of the securitisation process is also

related to the different role that the Special Purpose Vehicle (SPV) might acquire (see Box

1). The SPV is a unique entity the role of which is the acquisition of an identified pool of

assets. The SPV is the holder of the collateral within the securitisation. The owner of the

SPV, whether it is the originator or a pool of originators, bears the risk of the SPV. A

possible guideline is that an originator could establish only one SPV for all the transactions of

the same type to be issued, instead of one SPV for each transaction. In the case of a single

SPV for all transactions, since the vehicle is immediately available, transaction costs will

diminish and the process of securitisation will speed up.


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23

In cases in which a group of originators considers creating a common SPV for the ABS

market (whether or not specialised by type of collateral) the risk will be borne by the owners

of the SPV. A Banque de France initiative to re-start the securitised SME loan market has

worked along these lines.

The creation of a joint SPV within national borders allows for sharing of set-up and operating

costs. Standardised legal documentation used by the originators will also reduce costs and

operational frictions, and make the SPV a very efficient credit claims mobilisation tool.

Whether such a set-up is legally compatible with each country's legal framework, and

whether such a choice could be more efficient from the market point of view, are however

open questions. The answer in part would depend on the risk weighting assigned to the

shareholders of the SPV.

Another reason for the creation of a joint SPV is that, once a common ABS structure with the

same collateral type is defined ex ante, there will be less flexibility or creativity in the

structuring phase, so that certain type of collateral, if available in volumes that are

insufficient to respond to the structuring requirements (such as over- collateralisation

criteria), could not be used. While in the past the lack of assets to create credit enhancement

in the form of over-collateralisation was compensated for by other forms of internal or

external credit enhancement, the absence of this choice in the new system could place a limit

on the participation of small and medium players in the ABS market, because of lack of

collateral. The problem could however be circumvented through the creation of an SPV at

national level, or jointly created by small originators. This would stimulate more

consolidation of the banking sector within countries.

In summary for option 2, we can conclude that, under the Single Supervisory Mechanism

headed by the ECB, there is ample room to refine all the existing regulation, as we have

discussed, in order to create a large pan-European market for simple, robust and transparent

ABS products. However, it is also clear that, because of the time it will take to implement the

necessary regulatory changes, these developments might only be relevant for the next

business cycle, unless this process is accelerated.

Option 3: Act bold

If direct outright purchases in the ABS market are really meant to significantly

enhance the functioning of the monetary policy transmission mechanism within the next few


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24

months (ie working immediately, and not just as potential amplifiers of the TLTRO), there is

a third alternative to the fast/small versus slow/large options we have analysed. A further

option, already suggested by Claeys et al (2014), is the direct purchase of RMBS.

In fact, the improvement in banks balance sheets would be marginal (given the lower capital

absorption of these instruments), while clearly a careful assessment should be made of the

need to minimise the impact of RMBS purchases on house prices (and the ensuing wealth

effects for households) in the euro area, in order to avoid new bubbles, or to stop the

correction of existing ones. While the monitoring exercise now routinely carried out as part

of the Excessive Imbalance Procedure can be deployed to avoid such a risk, the fiscal

implications of these actions should nevertheless be carefully assessed.

XI. MORTGAGED BACKED AND MORTGAGE BACKED SECURITIES IN THE EU: A

COMPARATIVEANALYSIS

A. Introduction

The bulk of outstanding European RMBS issuance is from the UK, Spain, the

Netherlands, and Italy. As one shift focus from one country to another, RMBS dynamics

change dramatically, and thus, a good grasp of the differences is required for any proper

analysis.22A very important distinction is that most mortgage lending in the United States is

treated as asset-based, meaning that if a borrower defaults, the lender typically can only

foreclose on the mortgaged property to recover any losses (even in the judicial foreclosure

states, lenders rarely choose to file for a deficiency judgment).23In Europe (and most of the

rest of the world), mortgage lenders typically have full recourse to the borrower and in case

of default, the lender can file a lien against the borrowers other assets and future income

streams. This creates a much larger incentive in Europe to repay the mortgage, whereas US

borrowers can default on their loan and abandon their home, with the main impact being a

negative mark on their credit score. In addition, the US government plays a much larger role

in the mortgage market, indirectly holding the credit risk of more than 50% of outstanding

US mortgages via Government Sponsored Enterprises (e.g., Fannie Mae, Freddie Mac, and

22 Hikmet Sevdican & Mike Li, European Residential Mortgage-Backed Securities: Key Considerations,

DYNAMICCREDIT 2(2014)available at23

UK Prime MT vs. US Jumbo RMBS, Banc of America/Merrill Lynch, August 20, 2009


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25

Ginnie Mae), and guaranteeing approximately 85% of new mortgage production, whereas the

private sector holds most ofthe mortgage credit risk in Europe.

B. Securi tisation structure

The typical securitisation is a standalone transaction where a pool of assets backs a

single RMBS transaction and its tranches. US and Dutch RMBS are structured in this format.

However, the US predominantly has pass-through transactions, where payments are filtered

through the cash flow waterfall to be paid to the note investors. Dutch transactions typically

feature the loan originator acting as a swap counterparty, which receives all of the mortgage

payments and in exchange pays the required amounts to the noteholders and guarantees an

amount of excess spread (net mortgage interest less coupons due on the notes) in the

transaction. Given an equivalent level of defaults and most all else being equal, Dutch RMBS

will perform better relative to US RMBS. However, Dutch RMBS performance becomes

much more aligned with the health of the institution sponsoring the transaction, potentially

impacting cash flows as well as market perception of risk. This is a double-edged sword as it

adds a layer of support to the transaction while introducing an additional element of risk. 24

In contrast, U.K. Prime RMBS are largely structured in a master trust format, similar to credit

card securitisations, where a pool of mortgages supports several securitisations havingvarious currencies, maturities, coupons, and redemption dates. The first key difference is that

master trust pools are revolving pools, where the pool composition changes on a month-by-

month basis as old loans amortise and new loans are added to the trust, making issuance

vintage less meaningful than in static transactions. The second is the complicated system of

rules governing the trust payment waterfall as trust cash flows are allocated to pay different

notes depending on the delinquency rate, mortgage prepayment speed, and upcoming tranche

redemption dates.

A common focus when valuing most European RMBS is assessing the likelihood of the

transaction being redeemed on its expected time call date3. This assessment is based on a

number of factors, the most important of which are: the capacity of the sponsoring institution

to do so, either via taking the mortgage loans back onto the balance sheet or through a new

bond issuance; its motivation to retain access to the securitisation markets as a future funding

option, and the performance of the transaction.

24Id.


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26

As the sponsoring institution will take the mortgages and the reserve fund, a cash account

established for the securitisation to absorb losses not covered by excess spread, onto its

balance sheet (at least temporarily), the effect on its capital adequacy ratios is of paramount

importance. Based on current secondary market spreads, calling a transaction and transferring

the remaining portfolio into a new issuance is likely to be an expensive proposition with

regard to funding costs.

However, the size of the reserve fund can often determine whether it is economically feasible

for the call option to be exercised. If losses are expected to be less than the projected

cumulative excess spread, then calling a transaction would generally result in the

improvement of the sponsors capital. The reserve fund is typically greater than the risk-

weighted capital charge of the mortgages in a performing securitisation and the benefit to the

capital ratios would help mitigate the impact of the higher funding costs. However, a

transaction which has already begun or is expected to use its reserve fund to offset losses is

likely to have a negative impact to a banks capital ratios if it is called (as the risk-weighted

capital charges relating to the poorly performing mortgages overtake the benefit from the

remaining cash reserves). Particularly where bonds are priced to the call date, greater than

anticipated pool deterioration can result in higher required yield for both the additional risk of

principal loss and the potential extension of cash flows. The latter issue has a much greaterimpact on required yields in the case of a time call as opposed to a clean-up call, because it

affects senior bonds severely as well.

While a framework has been described by which to analyse these types of securities, it is far

from a definitive guide to European RMBS. Accurately valuing European RMBS is not a

simple task, even for many familiar with the asset class. Inconsistent information reported by

servicers, the difficulty of finding historical data points, significant differences between

mortgage markets within the European Union, and the difficulty of appropriately pricing the

bonds make the analysis process a challenging proposition. However, for those who can

navigate the obstacles, investing in this asset class can be a lucrative endeavour.

XII. MORTGAGE BACKED SECURITIES (MBS)IN INDIA

The beginning of Mortgage Backed Securities (MBS) in India was made in August 2000,

when National Housing Board (NHB) issued the first MBS with issue size of INR 59.7

crores, originated by HDFC Ltd. Till October 2004, NHB has made 10 MBS issues in the


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27

secondary market with total issue size of INR 512.27 crores and comprising of 35,116

housing loans, shown in exhibit 1.

While the number of housing loans has increased, the number of MBS issued so far has

remained more or less constant for all the years since 2000, on the basis of total issue size.

Also, while the volumes of securitisation in general have continued to zoom, the RMBS

activity remains limited. The MBS issued so far has been for an aggregate outstanding

principal of INR 663.91 crores, shown in exhibit 2. The aggregate principal outstanding

against the MBS issued till 2003 was just 0.5% of the total disbursements made over these

years. On an annual basis the percentage of loans converted into MBS of the total

disbursements made in that year has declined from 0.96% in 2003 to 0.34% in 2003. While

2004 has seen comparatively better performance with MBS of issue size INR 144.75 crores

already issued, the performance of India with regard to developing the secondary market for

home mortgages is far from satisfactory.

One possible explanation for the declining interest in issuing mortgage backed securities is

the fact that the spreads in mortgage lending have come down drastically over time. Interest

rates have declined, and there is stiffening competition. Housing finance has suddenly

become the coveted asset class for a bank to house on its balance sheet which has been

responsible for squeezing the spreads. If the spreads are thin, will mortgage originators

securitize? Essentially, the question is one of mindset. There is a notion that securitisation

transactions were driven by a gain-on-sale motive25. If gain-on-sale is the driving motivation,

it is understandable that where spreads have dwindled, the extent of gain-on-sale will become

less significant. However, the gain-on-sale is one of the many motivations in securitisation.

The most predominant motive is the reduced cost of funding in any mature securitisation

market, a securitisation transaction must result into lower weighted average cost of funding.

If it does not, it is a clear signal that either the rating agencies are dictating too high credit

enhancements, or that the investors are demanding too high premiums possibly due to lack of

25Gain on sale is the profit that is booked, upfront, when a portfolio of assets is securitized. In accounting as in

legal parlance, securitisation is a sale, and the sale might result into a gain or loss on sale. Usually, securitisation

transactions result into a gain on sale, if there is a positive difference between the rate of return inherent in the

mortgage pool and that in the issuance of securities which is obviously expected. Even if the pool is sold at

par, but with a contractual right to derive profit in future in form of service fees or any other retained interest, if

conditions of off-balance sheet accounting are met, accounting standards will permit profit booking by bringingon books the fair value of the retained interest.


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understanding of the inherent risks in RMBS. Both these factors are signals of market

inefficiency inefficiency is necessarily transient, if the extraneous hurdles to development

of the market are removed. So, we expound in this article that the reduced interest in

securitisation is in fact the product of inefficiencies of the system, which have set in process a

vicious cycleinefficiency breeding inefficiency.

XIII. ASSET BACKED SECURITIES (ABS)IN INDIA

(a)Auto loans:

Though securitisation was made popular by housing finance companies, it has found

wide application in other areas of retail financing, particularly financing of cars and

commercial vehicles. In India, the auto sector has been thrown open to international

participation, greatly expanding the scope of the market. Auto loans (including installment

and hire purchase finance) broadly fulfil the features necessary in securitisation. The security

in this case is also considered good, because of title over a utility asset. The development of a

second hand market for cars in India has also meant that foreclosure is an effective tool in the

hands of auto loan financiers in delinquent cases. Originators are NBFCs and auto finance

divisions of commercial banks.

(b)Investments:

Investments in long dated securities as also the periodical interest instruments on

these securities can also be pooled and securitised. This is considered relevant particularly for

Indian situation wherein the FIs are carrying huge portfolios in Government securities and

other debt instruments, which are creating huge asset-liability mismatches for the institutions.

Government securities issued domestically in Indian Rupee can be bundled and used to back

foreign currency denominated bonds issues. It would more be of the nature of derivative.The

subordinated Government securities are intended to absorb depreciation in the value of the

rupee thereby protecting to certain extent the senior securities that the Government securities

back. The senior securities are directed at the international capital markets and are structured

using offshore SPVs by countries like Mexico.

Similarly, under the STRIPs mechanism, the interest coupons on the Government dated

securities are separated and traded in the secondary markets. Such interest instruments can

also be bundled and securitised in the normal asset securitisation method.


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(c) Others:

Financiers of consumer durable, Corporates whose deferred trade receivables are not

funded by working capital finance, etc are Originators of other asset classes amenable to

securitisation. Corporate loans, in a homogeneous pool of assets, are also subject to

securitization There is virtually no known instance so far in the United States or in other

countries of an ABS transaction having failed. This is despite the fact that the markets for

ABS are exceptionally large. Industry experts attribute this to three main factors. ABS

transactions are always planned, prepared and carried out with great care. Second reason is

the intrinsic valueof the paper and in particular the high level of transparency on the quality

of the underlying assets. Third, ABS transactions are sponsored generally by large and well

known institutions which can't afford to jeopardise their reputation with investors, the

majority of which are institutional investors.

XIV. LEGAL INFRASTRUCTURE FORABSAND MBSIN INDIA

By far, the most significant barrier to development of securitisation in India is the

presence of certain antiquated laws that date back to the 19thcentury and are completely out

of place with the present market reality. Unfortunately, these laws are stumbling blocks to the

development of securitisation in the country. It is not that this paper brings those issues to thenotice for the first time this has been done by every single committee that went into the

matter, starting from the Andhyrujina panel to the several consulting groups of the Asian

Development Bank. However, no concrete measures have been taken by the government to

resolve the issues.

A. The Secur it isation Acta futi le exercise

To many, it might sound surprising that there is an enactment called the Securitisation

and Reconstruction of Financial Assets and Enforcement of Security Interests Act

(SARFAESI) enacted in 2002. The long title suggests that the Act does something about

securitisation in fact, the Act is focused on enforcement of security interests, and whatever

skeletal provisions it had enacted about securitisation have been completely useless in

practice. The whole scheme of the Act was flawed it envisaged the concept of a

securitisation company, supposedly a company in the business of securitisation, which will

be licensed and regulated by the RBI. No such companies have come into existence, and

therefore, the provisions of the Act on securitisations have been of no avail whatsoever.


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Perhaps in realization, the Finance Minister announced as a part of the Budget Speech

presenting the Union Budget 2005 that the government will appoint a high-powered

committee to examine all aspects of securitisation transactions.

B. Problems of the exi sting l egal system

The existing legal system, as far as it relates to mortgage backed securitisation, suffers

from two basic legal infirmities. It was easy to resolve both of these without involving any

Centre-State issues and it is only surprising as to why this has not been done.

C. Mortgage debt regarded as immovable property

The first problem is that a mortgage backed security, being an interest in a mortgage,is treated by law as an immovable property. This may be resolved by providing, that a

receivable which as the security of a mortgage will not be deemed to be an immovable

property, thus taking mortgage receivables out of the domain of the Transfer of Property Act,

a law with its foundations in the 19thcentury.

D. Stamp duty issue

The other issue is the issue of stamp duty. The stamp duty also originates from an

archaic concept of English law whereby a receivable (actionable claim) is treated as a

specific form of property, for the transfer of which a written instrument is required. This

principle is enshrined in sec. 130 of the Transfer of Property Act. If this provision was

deleted or amended, obviating the need for a written instrument, one would not need a

conveyance to transfer a mortgage debt, and therefore, the whole issue of stamp duty could

be resolved in one stroke.

Currently, the system works under an extremely inefficient structure of stamp duty

concession notifications. Several states have issued such notifications, notably, Maharashtra,

Gujarat, Tamil Nadu, West Bengal, etc. As could be expected, the language of the

notifications is different, and interpretations are mind-boggling. It is easy to understand why

securitisation pools have been restricted to those states where these notifications exist, thus,

keeping the borrowers from the rest of the country outside the securitisation framework.

The stamp duty issue is being made to look like a Centre-State issue, but in fact it is not.

None of the States would have projected huge revenues out of securitisation stamp dutiesinStates which have not made the stamp duties practical enough, there are not any securitisation


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transactions at all. So the options are clear either make it practical, or the transactions do

not happen at all.

E. Mortgage foreclosure laws

Another difficulty commonly cited so far was the lack of mortgage foreclosure laws.

Under traditional civil law (sec. 67 of the Transfer of Property Act), mortgage foreclosure

necessarily required the decree of a civil court, which could take anywhere between years to

ages.

This problem has substantially been addressed in terms of legal infrastructure - only requires

institutional structure to handle foreclosures. The SARFAESI Act made it permissible for

banks (and notified finance companies) to foreclose mortgages (and other security interests)

without approaching a Court. While the legal provision therefore exists, all that is required is

development of institutions that could carry out the law and logistics inherent.

F. Clar ity on taxation

Securitisation structures are going on without any clarity whatsoever on the tax treatment of

special purpose vehicles. Securitisation SPVs are created as trusts, and it is believed, without

any precedent or basis, that they will be tax transparent and that the tax will be imposed on

the ultimate investors.

Given the fact that the pass-through rules in the US taxation are quite complicated and not

every transaction qualifies for pass-through or see-through treatment, believing securitisation

SPVs to be tax transparent may be quite dare-devilish. In fact, with the kind of recycling,

reconfiguration of cash flows and stripping of inflows, it is quite likely that the transactions

are not treated as pass-through.


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Exhibit 1: MBS Issued by NHB in India

NHBSPV Originator

Date

ofIssue

Pool Size Issue

Size

(incrores)

PricingStructure

MBSCoupon

CreditEnhancement

Rating

(with

AgencyName)

No. ofLoans

PrincipalOutstanding

HP1 HDFC Ltd

Aug-

00 8329 88.32 59.7 Par 11.85%

A-B Structure

& Guarantee

of Rs. 1.10 Cr

AAA

(So) by

CRISIL

LP1 LIC HFL

Aug-

00 2777 47.54 43.84 Par 11.85%

A-B Structure

& Cash

Collateral

AAA

(So) by

CRISIL

LP2 LIC HFL

Apr-

01 4292 74.22 46.84 Par 10.25%

A-B Structure

& Collateral

AAA

(So) by

CRISIL

CP1 Canfin Ltd

Apr-

01 4257 63.4 44.85 Par 10.25%

A-B Structure

& Cash

Collateral

AAA

(So) by

CRISIL

CP2 Canfin Ltd

Jun-

02 4256 85.35 58.19 Par 8.90%

A-B Structure

& Cash

Collateral

AAA

(So) by

CRISIL

BP1 BOB HFL

Apr-

03 3548 77.15 59.65 Par 6.89%

A-B Structure

& Cash

Collateral

AAA

(So) by

CRISIL

CP3 Canfin Ltd

Jun-

03 2007 64.13 54.45 Par 6.25%

A-B Structure

& Cash

Collateral

AAA

(So) by

CRISIL

DP1

Dewan

HFL

Mar-

04 3155 69.79 61.83 Par 6.98%

Bank

Guarantee

@2% of PTC

A Rs. 1.24

crore at time

of issue

AAA(So)

by

FITCH

and

CARE

AB-1

Andhra

Bank

Mar-

04 1437 50.36 42.95 Par 6.15%

A-B Structure

& Cash

Collateral of

Rs.68 lakhs

AAA(So)

by

CRISIL

BH-1 Birla HFL

Mar-

04 1058 43.65 39.97 Premium 6.60%

A-B Structure

& Cash

Collateral of

AAA(So)

by ICRA


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Rs.9.81 crore

Total 35116 663.91 512.27

Note: All amount in INR Crores

Source: National Housing Banks Annual Reports and www.nhb.org.in

Exhibit 2: Issuance of MBS in India (Year wise consolidation)

S.No. Year

No. of

Issues

No. of

Loans

Principal

outstanding

Issue

Size

Total

Disbursement

% of loan

issued as

MBS

1 2000 2 11106 135.86 103.54 14110.29 0.96%

2 2001 2 8549 137.62 91.69 19058.68 0.72%

3 2002 1 4256 85.35 58.19 23858.43 0.36%

4 2003 2 5555 141.28 114.1 42026.86 0.34%

5 2004 3 5650 163.8 144.75

TOTAL 10 35116 663.91 512.27

Source: National Housing Bank


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XV. ASSET -LIABILITY MANAGEMENT

Article 6 of the Law on Mortgage-backed Bonds stipulates that mortgage loans shall be

included into the calculation of the principal cover at the value of their outstanding principal but at

no more than 80% of the mortgage appraisal value of the real estate as housing units, including

leased ones, and at no more than 60% of the mortgage appraisal value of the real estate as villas,

seasonal and holiday housing units used as collateral on mortgage loans. Substitution cover of

mortgage-backed bonds from any issue may not exceed 30% of the total amount of liabilities of the

issuing bank under that issue.

Mortgage-backed bonds cover from any issue (the sum total of the principal cover and the

substitution cover) may not be less than the total amount of liabilities towards the principals of

mortgage-backed bonds from that issue which are outstanding and in circulation outside the issuing

bank. In making calculations under the previous paragraph for mortgage-backed bonds and assets

constituting their cover denominated in different currencies, the official foreign exchange rate for

the Bulgarian levy to the respective currency quoted by the Bulgarian National Bank of the day of

the calculation shall apply. A loan recorded in the register of the cover of mortgage-backed bonds

from a particular issue may be repaid at any time by bonds of the same issue at their face value.

XVI. TRANSPARENCYBanks (the only eligible issuers of mortgage bonds) produce regular reporting to Banking

Supervision authority Bulgarian National Bank (BNB), and provide and publish financial

information on a monthly basis. The public banks are reporting issuers and submit all required

information to the regulated market Bulgarian Stock Exchange Sofia (BSE), as well as to the

Bulgarian Financial Supervision Commission (FSC). No additional specific measures in respect to

the mortgage bonds are currently announced.26

XVII. COVER POOL MONITORAND BANKING SUPERVISION

Cover pool is managed by the issuing bank which should have adopted internal rules for

maintaining the cover pool, the rules for access to the cover pool data base and the regularity of the

26

Taylor, J, "The Monetary Transmission Mechanism: an Empirical Framework", Journal of EconomicPerspectives, 9, pp. 11-26.


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update of the cover. Bulgarian National Bank carries out general assessment of the banks, including

issued mortgage bonds as part of general banking supervision.27

XVIII. SEGREGATION OF COVERASSETSAND BANKRUPTCY REMOTENESS OF COVEREDBONDS

After the record of the assets in the register as a cover of mortgage-backed bonds of a

particular issue may be used as collateral solely for the liabilities of the issuing bank on that issue.

The issuing bank may not allow any encumbrances on its assets constituting the cover of

outstanding mortgage-backed bonds. The issuing bank accounts assets recorded in the register of

mortgage-backed bonds cover separately from the rest of its assets.

The issuing bank shall keep a public register of the cover of mortgage-backed bonds issued by it as

the register is kept separately by mortgage-backed bonds issue. In case of declaring the issuing bank

bankrupt, the assets recorded as of the date of declaring the bank bankrupt in the register of the

mortgage-backed bonds cover shall not be included in the bankruptcy estate. Proceeds from the

liquidation of assets recorded in the register as a cover on a particular issue of mortgage backed

bonds are distributed among the bondholders from that issue in proportion to the rights under their

bond holdings. Any funds remaining after settling the claims under mortgage-backed bonds from a

particular issue is included in the bankruptcy estate.

The asset pool under the above mentioned paragraphs are managed by a holders trustee of

mortgage-backed bonds which is appointed by the bankruptcy court when it has been established

that the bank has outstanding liabilities under mortgage-backed bonds. The trustee is managing the

assets by individual mortgage-backed bonds issue.

The Trustee shall be a person who meets the requirements of Article 217, paragraphs 1 and 2, items

1-3 of the Public Offering of Securities Act and is not engaged in any relationship with the issuing

bank or any of the holders of mortgage-backed bonds which give reasonable doubt as to the

formers impartiality. The Trustee shall have the powers of an assignee in bankruptcy in respect of

the asset pool described above, as well as in respect of any outstanding liabilities of the issuing bank

under mortgage-backed bonds.

27

Orlowski, L, "Monetary Policy Regimes and Real Exchange Rates in Central Europe's TransitionEconomies", Economics Systems, 24, pp. 145-66 (2000).


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The Trustee shall manage the above mentioned assets separately for any mortgage-backed bond

issue. The Trustee shall sell the above described assets under the procedure set forth in Articles

486-501 of the Civil Procedure Code and shall account any proceeds to an escrow account opened

for each issue with commercial banks as determined by the Bulgarian National Bank.28The Trustee

shall publish in the State Gazette (Darzhavenvestnik) and in at least two national daily newspapers

the place and time for the tender for the sale of assets under the procedures of previous sentence not

later than one month prior to the date of the tender. The bondholders of any issue of mortgage-

backed bonds of a bank which has been declared bankrupt shall have the right to obligate the

Trustee to sell loans included in the issue cover to a buyer specified by them and the Trustee shall

follow precisely the decision of the Bondholders General Meeting under the previous sentence.

The liabilities of the issuing bank under a mortgage-backed bonds issue shall be deemed repaid

when the amount of outstanding principals of the sold loans becomes equal to the total amount of

liabilities on principals and interest accrued on the bonds prior to the sales.

XIX. BULGARIAN MORTGAGE SECURITIES MARKET INFORMATION

Since the adoption of the Bulgarian Law on Mortgage-backed Bonds in 2000 the mortgage

bond issues in Bulgaria total 28. There were no new issues in 2012. The volume of issued

mortgage-backed bonds is EUR 268.3 m originated by 11 issuing banks.

A. Market Demand for Securi ties

Currently the bond market in Bulgaria is equal to the government securities market. So far,

only few companies dared to issue corporate bonds. These are Prosoft AD, Kaolin AD, Energija AD

and the Black Sea resort Albena. All of the bonds are issued on the domestic market and are not

traded on the stock exchange (they were placed privately). Additionally, on the domestic market

were issued bonds of the Svistov Municipality and on the foreign market - small issue of eurobonds

of the Sofia Municipality.

Here are two examples of issues, which were placed successfully:

Prosoft AD issued 5-year corporate bonds in nominal value of BGL 300,000. The issue value is

equal to the face value of the bonds (the company took over all charges for the Securities

28Amended; issue 59 of 2006; in force on the date of entry into force of the Treaty of Accession of the Republic

of Bulgaria to the European Union; amended; issues 52 and 59 of 2007; amended; issue 24 of 2009; effective asof 31 March 2009.


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Commission, marketing, etc.). A "buy-back" option is included in the contract. The interest rate is

the base interest rate of the Bulgarian National Bank + 6p for the first three years and the base

interest rate of the Bulgarian National Bank + 6.5p for the last two years.

Kaolin AD issued bonds with total volume of BGN 2,500,000 and 10% interest rate. The issue of

Svistov Municipality was not very successful. The total volume is BGL 371,000 and only about half

of it was placed. 18% of the issue were acquired by municipal firms which actually had to gain

from the money collected by the Municipality from the issue.

So, the main issuer of bonds in Bulgaria is still the Government. Investors in Bulgaria could acquire

government securities on the primary or the secondary market. On the primary market they can buy

securities on the auctions organized by the Bulgarian National Bank. Only the so-called "primary

dealers" (approved by the Bulgarian National Bank and the Ministry of Finance) may participate in

the auctions. These are banks or investment intermediaries (as defined by the Law on Public

Offering of Securities). Investment intermediaries may participate with:

Competitive ordersfor their account or for the account of their clients

Non-competitive orders on the account of their clients, which are not banks or investment

intermediaries.

The Bulgarian National Bank determines before the auction the share of the government bondsoffered for competitive and non-competitive orders.

The Bulgarian National Bank buys back the government securities before its day of maturity on

decision of the Minister of Finance on auctions, too. The issue which is to be bought back could be

replaced by a new issue of government securities or the face value and the interest could be paid to

the holder. Only competitive offers are being accepted. Main players (buyers) on the market are the

banks, the insurance companies, the newly created Fund for bank deposits guarantee, pension

companies, and individual investors.29

B. Terms and conditions

Banks have largely unified the terms and conditions of the mortgage loans. This is the result

of substantial legal regulation by means of laws and regulations of this aspect of the operations of

the banking institutions. The regulatory provisions of the Law on Banks and the regulations issued

29

Nenovsky, N., Chobanov, P., Mihaylova, G., Koleva, D.(2008), "Efficiency of the Bulgaria Banking System:Traditional Approach and Data Envelopment Analysis", AEAF Working Paper, No. 1/2008.


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by the Bulgarian National Bank are mandatory for the crediting businesses. The goal set in the

restrictive provisions is to limit risks to banks in the course of their crediting operations. It should

be noted though that the provisions are most liberal in respect to first mortgage on a piece of real

property with appraisable market value which exceeds by 25 per cent the amount of the loan. These

mortgages have a risk weight of 50 per cent and are included in the risk component of the balance

sheet in an amount equal to half of their balance sheet value. Of lower risk weight are only the

assets of the bank invested in available (cash) funds, on sight funds in the banks checking

accounts, receivables from the government and receivables from foreign banks, organizations and

countries on the special list of the central bank.

In order to get a mortgage loan approved by the bank, the credit applicant should generally meet the

following requirements:

1.Good creditability: It is assessed by the ability of the applicant to fulfill his obligations in respect

to the loan transaction under the terms of the contract so as not to threaten his financial situation and

not to affect the interests of other persons. Natural persons prove their creditability by indicating the

sources and amount of their incomes for a preceding period of time and the anticipated sources of

income for the period of payback of the loan. The individual should have sufficient funds left to

ensure his support after deducting the monthly mortgage payments from his income.

The credit rating of businesses is proven by an analysis of the information in their accounting

documents for a past period of time and an analysis of the forecast cash flows expected from the

expansion of operations or the development of a new operation.

2. Positive rating of the individual credit risk of the applicant, i.e. the likelihood of him failing to

fulfil or of him getting into a situation where he cannot fulfil the terms of the credit contract.

3. The value of the collateral should match the amount of the loan. There is no legal regulation of

the methodology of the appraisal. The law does place, however, certain requirements in respect to

the persons who are doing the assessment. They should possess licenses to engage in such activity

and should operate independently of the bank. The appraisal of the property must also provide

indication of the methodology used. It is often the practice of banks to have their own experts re-

examine appraisals made by outside assessors.

4. A mandatory element of the mortgage contract is the requirement that the client provides

supplementary collateral if the market value of the real property used should drop below therequired minimum corresponding to the amount of the loan.


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5. There is a practice in the Bulgarian banking market for banks to allow credit users early

redemption of loans. There are just a few banks, which charge fees for early redemption of loans,

and such fees cover a portion of the loss of interest by the bank.

C. Pricing

The elements, which form the price of the mortgage credit are as follows:

1.Interest costs

As credits carrying the lowest risk of loss mortgage loans have the lowest interest rates. It is

usual practice for banks to set interest rates of loans depending on the purpose of these loans. The

interest rate covers the price of the monetary resource deposited increased with the profit required

from the credit transaction. A risk supplement is added to this base interest rate which in the case of

mortgages is the lowest possible.

Two approaches are used in everyday practice for assessing interest on loans: compounded interest

(redemption by annualized instalments) and simple decursive interest (redemption of principal and

interest on the loan calculated by the staircase method). With the staircase method interest is

accounted on the remainder of the loan whenever there is a change in the amount of that remainder

or whenever there is a change in the interest rate.

In the event of the principal becoming overdue or some other violation of the contract, the bank

accounts penal interest on the amount overdue until the elimination of the violation. The penal

supplement is a percentage added to the regular interest rate.

2.Fee for examination and appraisal of the collateral

This is a one-time fee collected upon submission of the application for the loan, which

covers the banks expenses for studying the client, the purpose of the loan, for appraisal of the

collateral, for obtaining the opinion of a credit expert and other costs.30

30

Alexandru Minea and Christophe Rault, Some New Insights into Monetary Transmission Mechanism inBulgaria, Journal of Economic Integration, Vol. 24, No. 3 (September

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