Residential mortgage based bond market – Building it brick by brick
“Housing for all” is our government’s aspirational program that aims to create homes to every family before 2022 ( Our 75th independence year ). Our government has already announced incentives on both demand and supply side to achieve this goal. Tax holiday extension for affordable home developers on the supply side and then additional tax deduction to the tune of 1.5 lakhs on the home loan interest from the demand side but there comes the problem from the financial institutions. These institutions which are Banks and Housing finance companies have to deal with the asset liability mismatch as their assets are long-term and liabilities short-term.
This is even more acute for banks and housing finance companies (HFCs) that offer home loans. Here, typical loans could be up to 30 years whereas liabilities are for 5 years. The liabilities for banks come via deposits which are more stable whereas HFCs rely on borrowings from banks and issue bonds that are less stable. Under the ambitious ‘Housing for All’ programme of the government, India needs to build around 8-10 crore houses by 2022. Buying or building a home is the largest expense for most individuals. Borrowing money for home buying is, thus, very common.
This target is highly ambitious, given that the current market value of housing in India is estimated at Rs 150 lakh crore and it is like creating the entire current housing market in just three years!
By the end of 2018-19, banks and HFCs combined have home loans outstanding at Rs 20 Lakh crore, accounting for 58 percent and 42 percent, respectively. In 2011, the share of HFCs in home loans was 33 percent, which has steadily increased to 42 percent today. HFCs are nothing but NBFCs and have a riskier liability profile than banks. We have seen how HFCs have been embroiled in the recent NBFC crisis.
The point to note is achievement of targets under ‘Housing for All’ will require funds to the tune of Rs 100-115 lakh crore, which is 5-6 times of the existing home loan market!
So, how to rise a fund that solves the asset liability mismatch of the HFC’s and banks? There are two mechanisms that this maturity mismatch can be addressed – by accessing long maturity liabilities with other types of financial institutions to fund home loans and by reducing the ‘holding period’ maturity of the home loans. In the financial system, the institutions that has the longest maturity liabilities are life insurers and pension funds.
So recently the committee formed by RBI submitted a report on developing a housing finance securitisation market to nudge India towards a more market-based financial system. The banks and HFC’s can now sell their loans in the form of bonds to third parties who are willing to buy it therefore transferring credit risk.
We could say that the origins of 2008 crisis lay in the home loan securitisation market. In 1990’s the banks in united states started giving loans to those with poor credit scores ( Or FICO score as they call it ) because back then their government had something close our “Housing for all” program. Banks also found sneaky little ways to fool their regulatory institutions to get AA ratings for their mortgage bonds even the underlying loans in those bonds are less likely to be paid back. But overall the crisis happened because of poor regulatory checks and too much greed of those who sat on the top echelons in investment banks.
India already has a securitisation market due to RBI guidelines in 2006 and 2012. The norms allowed two types of securitisation models.
- Direct assignment (DA)
- Pass through certificates (PTC).
Till now majority of the transaction in securitisation took place via DA model in which the originator will pool the loans sell it to the investors by prior negotiations. The Committee noted that securitisation done through the DA route involves customised, bilateral transactions which keeps the details of transaction (such as valuation, pool performance, prepayment ) in private domain. This inhibits other participants (such as mutual funds, insurance and pension funds) from participating in transactions.
This brings us to the next method pass through certificates (PTC) in which the pooled loans are sold through an intermediary, set up as a special purpose entity. But selling it through this model means they have to pay higher stamp duty and have to fulfil many regulatory, legal requirements like they have to deal with the Transfer of property act etc,. So, that discouraged originators from following this model.
The securitisation market has increased 10-fold during 2006-19 and is currently valued at Rs 2.6 lakh crore. However, DA comprises nearly 75 percent of the overall market and 90 percent when it comes to home loans securitisation market.
So, The RBI formed committee has made a host of suggestions to push for PTC model. One main reason for dominance of DA approach is lack of standardisation and transparency. The transaction costs due to stamp duty, registration and documentation also lead to more number of transactions under DA than PTC. These transaction costs have to be minimised to make level-playing fields for PTCs.
Under the old guidelines, the originator should hold the securities for a minimum 1 year and have to maintain equity at 10 percent. The committee has argued that for mortgage backed securities, the period should be lowered to 6 months and equity at 5 percent. The securities under PTC should be eligible for repo transactions with the RBI and the provident fund, pension fund and insurance companies should be mandated to invest 5 percent of their assets in PTCs.
The idea is to help banks and HFCs lower asset liability mismatches and lend more aggressively towards the government goals of creation of $5 trillion economy and Housing for All.
Anyway, the creation of these markets will also bring new players into the financial system and move India towards a more market-based framework and lower reliance on banks. But they come with their own risks as well and we all saw them come together in 2008 crisis. Such policies will always have some negative aspects but we have to see the bigger picture here and achieve our goals. Hopefully our regulators will implement and monitor its progress in a way where there will be no space for such mistakes.