The purpose of this article is make a case for the capital market model for residential mortgage-backed securities in India, in both forms: (a) agency-backed, that is, with intermediation of apex agency like the National Housing Bank; and (b) non-agency or private label securities.
We first define the objective – that is, development of housing refinance market and the relevance of securitisation. Next, we see the relevance of the two securitisation models – agency-backed and private label. Next, we outline the hurdles in the process and the need for regulatory refinement. Finally, we make a quick comparison of the costs and the benefits of the exercise.
The project involves studying the Indian mortgages market and identifying the gaps in the mortgages market and identifying the extent of unfulfilled demand for housing in India. The project also involves studying other developed and semi-developed secondary mortgages market of the world, mainly US mortgages market. For the sake of comparing it with a comparable market, we have chosen Malaysia, though, evidently, the Malaysian system of refinancing mortgages is surely not a role model. The comparison with Malaysia serves the purpose of juxtaposing India with a market which is substantially similar. Comparison with the European market would not have provided an apple-to-apple comparison.
Using the demographic statistics of India and the performance of mortgage securities in USA and Malaysia, the size of secondary mortgages market in India was estimated using various methodologies.
The project involved identification of various pre-requisites for a vibrant secondary mortgages market and coming out with recommendations for the framework that is required for the development of secondary mortgages market in India and solution to specific issues outlined in the report. The regulatory and other hurdles were analyzed based on the first co-author’s association over long years as an educator and consultant in securitisation transactions. The recommendations are also based on the first co-author’s knowledge and intuition.
The Indian Scenario
4.1Housing Status in India
The percentage of houses to population was 24.26% in 2001, up from 21.87% in 1981. In absolute terms the number of houses grew by 27.7%, from 19.5 crores in 1991 to 24.9 crores in 20019, and at a marginally growth rate of 27% in number of households, signaling a marginal improvement in housing situation. The proportion of households living in permanent structures rose from 41.7% in 1991 to 51.8% in 2001, on account of sharp increase in the number of permanent houses from 6.3 crores to 9.9 crores. The number of households living in semi-permanent structures also grew from 4.7 crores to 5.8 crores. But a high proportion of 38.5% of households still lives in one-room structures in 2001, which was 40.5% in 199110. These statistics reflect the poor availability and quality of housing infrastructure in India.
The financing through organized sector accounts for only 25% of the total housing finance in India. The housing finance sector has grown at a cumulative average growth rate of around 39% on the average during the last 3 years11. However, this performance notwithstanding, the mortgage to GDP ratio stood at an abysmal 3% in India in 2001 when compared to 57% in UK, 54% in USA, 40% in EU, 7% in China, 17% in Thailand and 34% in Malaysia. This comparison apart the disbursements made by financial institutions to the housing sector amounted to only 1.81% of GDP at factor cost at constant prices (1993-94) in 2002-03 and in 2003-04 it was 2.91%12. This includes the disbursals made towards rehabilitation after Gujarat earthquake and Orissa cyclone.
The growth of housing finance business in the last 5 years has been due to the keen interest evinced by the commercial banks in this sector, which have slowly but surely transformed themselves from development banks to consumer banks. The growth potential further gathered momentum through continued fiscal and monetary fillips and budgetary provisions. The burgeoning middle class, increasing purchasing power, changing demographics and increasing number of nuclear families, scaling down of the real estate prices and a softer interest rate regime and traditionally low default rate resulting in low non performing assets as compared with the other sectors also contributed to the growth.
4.2Mortgage Backed Securities 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 secondary market with total issue size of INR 512.27 crores and comprising of 35,116 housing loans. The details of all the MBS issued by NHB are given in Exhibit 5.
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, as shown in Exhibit 6. 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 motive13. 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 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 cycle – inefficiency breeding inefficiency.