7.2Institutional Framework – NHB in a new role, or a new specialised agency for secondary market in mortgages
Under the present institutional framework National housing Board (NHB) is the apex level financial institution for the housing sector in the country and performs the role of promotion and development, regulation and supervision, financing, development of secondary mortgages market through securitization of housing loans, and promotion of rural housing.
While all the functions that are being carried out by NHB are essential and many more functions will also have to be carried out, if we ever intend to provide a roof over the head of millions of Indians who haven’t got a house, the prevailing institutional framework is not sufficiently equipped to meet the challenges of the future.
First of all, NHB is currently mainly engaged, apart from its regulatory position, in the role of being a refinancing body. The perils of creating a refinancing behemoth have already been highlighted earlier. Though NHB avowedly does not take the risks of the mortgage pools that it refinances, it is not immune from the same. The funding of NHB’s own balance sheet comes from various sources, which include the capital market. There are some tax subsidies in certain of the funding liabilities of the NHB – for example, capital gain bonds.
This structure is surely not efficient – if the objective is to provide a capital market window whereby ultimate investments in mortgage loans can be funded (an investment in NHB is essentially an investment in mortgage loans), the same can be achieved more efficiently by securitisation. The current practice of NHB is to provide with-recourse funding to the mortgage institutions, whereby there is no integration of the credit risk of the mortgage loan pool with the effective capital of the mortgage originator. All NHB does is to lay down regulatory capital requirements – which obviously do not distinguish between the risks of different portfolios. On the other hand, securitisation will directly link the level of credit enhancement with a scientifically estimated measure of stressed risk of the pool, thereby ensuring more sound investment avenue for the capital market investors.
Therefore, we recommend that NHB may gradually increase its role in intermediating in the securitisation market, rather than refinancing mortgage originators.
The intermediation in the securitisation market may also take three forms:
By providing a facilitation role as above, coupled with a credit enhancing role, where NHB absorbs credit risk above a certain first loss piece retained by the mortgage originator. There are models, for example, from KfW in Germany, that may be either emulated or modified to suit requirements. We call this NHB-credit-enhanced approach.
By being a buyer of mortgage loans, minus the servicing function, with NHB providing warehousing funding, as also securitising the portfolios thereafter. We call this pool-of-pools approach.
The first model is being pursued by NHB currently, with all the inefficiencies of the system on which we dwell later.
The second model provides a more active role for NHB – where, being a mezzanine loss absorber, NHB inherently also provides a degree of comfort to retail investors that the pool has been analyzed by an apex institution. If the objective be to attract retail investors to invest in the mortgage market, this kind of role (unless the third role becomes a reality) would really be commendable. In addition, if the government considers tax incentives to be necessary to attract retail savings, the tax benefits that today attach with NHB’s bonds may be granted to the NHB-credit-enhanced securitisation structure suggested above.
The third model should be the ultimate objective. As the supervisor of the mortgage financing business, no one is better suited to buy mortgage loans than NHB. With or without a first loss support, NHB may buy mortgage loans minus the servicing, leaving the servicing fees, origination profits and a compensation for the first loss support, if any, with the originator. These commingled pools may thereafter be securitized. In this “pool-of-pools” securitisation, there is far greater diversification than ever possible in any securitisation.
In our suggested model, there is very little additional credit burden on NHB – therefore, hardly any need for additional capital infusion into NHB. On the contrary, it may be argued that the credit risk of NHB will substantially come down, as also its balance sheet size – NHB might even eventually think of returning a part of its capital to the government. The credit risk with NHB in our models will be no more, and in fact will be arguably lesser, than the risk being taken currently in its refinancing role.
Specialised securitisation agency for RMBS
We have also at length considered whether it would be preferable to have NHB get into this securitisation promotional role, or to reserve the same for a specialized secondary market agency. There are arguments on either side. The advantage of retaining NHB as a the securitisation agency albeit with enhanced role as suggested by us is that we are not proliferating institutions. After all, every new institution needs capital, manpower, and above all, might lead to an overlap of roles.
On the other hand, a separate specialized body for secondary market in RMBS might have its own advantages – primarily that of focus. NHB is currently also assigned a regulatory role – it registers and regulates housing finance institutions.
The question of separate body or NHB in an enhanced role is essentially a question that requires more interaction and since the rest of the recommendations in our article are not affected by the specialization question, we defer it for further thought.
7.3Development of other agencies – leave it to the market:
The securitisation market will also need at least two more agencies: private label securitisation service providers, and insurance or external credit enhancement providers. Both of these are market-related developments, and left to itself, the market will cause them to come up. Nevertheless, we discuss below these agencies:
Private label securitisation service providers:
We do not expect the entire mortgage origination market will be ruled by NHB. In fact, as developments in most markets evince, GSEs and private label transactions co-exist. The reasons for private label transactions are various – they include securitisation of non-conforming mortgages, or for reasons of staying outside NHB’s supervision over the transaction.
Currently, in the RMBS segment, there are no private label transactions. However, there are several private securitisation service providers in the ABS market, who, as needed, may provide support to securitisation transactions in the MBS segment as well. The services are typically provided by investment banks who have focused themselves on structured finance transactions. The other ephemeral services are those of SPVs etc. which can easily be developed to accommodate market needs.
In many countries, insurance companies cover pool losses beyond a particular level – this is common in USA, UK, Australia, etc.
Under the current refinancing model, most of the mortgage originators have not felt the need for this external credit enhancements. Insurance companies do not provide insurance against credit risk – but mortgage pool insurance covers may be provided, as the need is felt. We feel that this development is purely market-based, and there is no specific regulatory intervention required to make it happen.