Lars Nyberg: Swedish housing financing and the EMU
Speech by Mr Lars Nyberg, Deputy Governor of the Sveriges Riskbank, at Economics Day held at
HSB Bank, Stockholm, on 8 November 2000.
* * *
I would like to start by thanking you for inviting me to HSB Bank's Economics Day and giving me
this opportunity to talk about Swedish housing financing from an EU perspective.
Introduction
One of the main purposes of the Single Market and the introduction of EMU is to create a more
efficient market for goods and services, a market which is characterised by greater competition and
better products at lower prices. On the mortgage market, this should mean that borrowers can expect a
wider range of products, more choice of suppliers and lower interest rates.
The national mortgage markets in Europe vary considerably, as does their significance to the country's
economy. This is illustrated in the following diagram (Figure 1). In countries such as Germany,
Denmark, Sweden, the Netherlands and the UK, the total outstanding stock of loans with property as
collateral amounts to over 50% of GDP. In other countries, such as Greece and Italy, the
corresponding figure is less than 10%. The differences are mainly due to factors such as different
regulations, tax legislation and market structures in the different countries. As in Sweden, housing
financing issues have often aroused considerable political interest, a fact which is reflected in all of the
above factors.
The outstanding stock of European
mortgage bonds divided by GDP 1998.
70
60
50
40
%
30
20
10
0
UK EU
Italy
Spain
Ireland
France
Finland Austria Greece
Sweden
Portugal Belgium
Denmark Germany
Netherlands
Source: The European Mortgage Federation
In the EU, the value of the outstanding stock of loans with property as collateral was estimated at
around SEK4,500 billion at the end of 1999.1 This stock of loans in Europe is mainly financed through
various forms of borrowing, around 62% (Figure 2). The second largest source of financing,
approximately 19%, is through bonds, while a relatively new type of financing in the form of
securitisation comprises around 1% of the outstanding stock of loans with property as collateral. The
United Kingdom is the country in Europe where securitisation is most frequently used, followed by
France, the Netherlands and Belgium (Figure 3). The market for securitised assets is still rather
undeveloped in the other European countries.
Funding of mortgage lending in the EU.
Shares in per cent of the outstanding stock of mortgage lending by
the end of 1998.
Deposits
13%
1%
Dedicated
Savings
Mortgage Bonds
19%
62%
Securitisation
5%
Other
Source: The European Mortgage Federation
The European mortgage bond market.
Shares by country by the end of 1999.
2%
15%
Denmark
29%
1% Germany
Spain
7%
France
1%
Austria
Sweden
Norway
45%
Source: The European Mortgage Federation
The European market for housing bonds is currently dominated by three countries - Germany,
Denmark and Sweden. Together, these countries account for around 89% of this market (Figure 4).
ABS/MBS securitisation transactions by
country, 1997.
30
23,84
25
20
US$
15 11,44
6,8
Billion
1,54
0,9
0,65 0,7
0,03
1050
UK
Italy
Spain
France
Belgium
Germany
Switzerland
Netherlands
Source: OECD
Competition for customers
Although mortgages are a relatively straightforward and standardised financial product that should be
well suited to sell abroad, international mortgage sales have been limited to date. One probable reason
is that the mortgage market mainly targets private clients, which are hard to reach without using a
local distribution network. In this respect, the Internet should be able to lead to greater transparency
and competition, both by the credit issuers themselves supplying information and credit services over
the Internet and by Internet-based brokerage sites finding the cheapest mortgages for borrowers.
While Internet-based mortgage services are still a relatively new phenomenon, they are likely to
increase competition on the mortgage market. However, if we look at the spread between the cost of
borrowing and the lending rate for mortgage institutions, there is no indication that the interest margin
for mortgage institutions has fallen as a result of increased competition (Figure 5).
Mortgage institutions ́ long term interest
margin.
12
10
The new Internet-based players on the mortgage market are made up of those who mediate loans via
the Internet and those who issue credit over the Internet. Players such as Blockbid, Bolånebörsen,
Comboloan and E-loan search for and mediate the cheapest mortgages for borrowers. Europeloan, on
the other hand, is an Internet-based credit issuer that has operated in Sweden since February 1999. The
company, which also operates in Belgium and Germany, finances mortgages through securitisation.
As more than 70% of the households have chosen floating interest rates on their new loans raised in
the mortgage institutions during the last year, it could be suitable to look at the interest margin
between short borrowing interest rates for mortgage institutions and floating interest rates on housing
loans (Figure 6). This diagram suggests that the interest margin for mortgage institutions is now about
1.2% compared to about 1.5-1.7% during 1996.
Mortgage institutions ́ short term
interest margin.
1,8
1,6
1,4
1,21
%
0,8
0,6
0,4
0,2
0
Month May Feb Nov Aug May Feb
Year 1996 1997 1997 1998 1999 2000
Lending by mortgage institutions to the household sector amounted to about SEK600 billion by the
end of September 2000, compared to SEK581,6 billion at the beginning of the year. About 35% of the
households' total borrowing raised in mortgage institutions are loans with floating interest rates, ie
about SEK210 billion.
Another reason why cross-border activities have been limited so far is that the mortgage markets are
governed by national regulations. A third reason is that cross-border activities are exposed to foreign
exchange risk.
As long as Sweden is not a member of EMU, foreign players wishing to establish operations on the
Swedish mortgage market will have to offer loans in Swedish kronor, since Swedish borrowers are
unlikely to want to expose themselves to foreign exchange risks. However, if Sweden joins EMU,
interest rates offered to borrowers in EMU-affiliated countries will be directly comparable. A common
currency would make it easier for borrowers to assess which credit institution in the common currency
area offers the best conditions. Swedish borrowers will be able to raise loans in euro without being
exposed to foreign exchange risk, and access to potential lenders will increase.
The Swedish mortgage sector is currently dominated by five companies, one of which - SBAB - is
state-owned (Figures 7 and 8). These five companies cover around 97% of the market. Since
mortgages are a highly standardised product, the price, ie the rate of interest, will be a decisive factor
in the competition for customers. As competition on the mortgage market increases, the cost of
refinancing will become the decisive factor for mortgage institutions' possibilities to pursue a
profitable business. I will therefore devote the rest of this speech to the question of refinancing.
The Swedish mortgage institutions ́
balance sheets, 1999.
2%
Stadshypotek + Handelsbanken
10%
Hypotek (33 %)
1%
SPINTAB + Föreningsbanken
Kredit (28 %)
33%
SBAB (13 %)
13%
Nordbanken Hypotek (13 %)
Skandia Banken Bolån (1%)
13%
SEB-Bolån (10 %)
Venantius (2 %)
28%
Swedish mortgage institutions ́ shares of
borrowing on the security market (money
market instruments and bonds), 2000.
3%
7%
SPINTAB
13%
35%
Stadshypotek
SBAB
NB Hypotek
SEB Bolån
18%
Övriga
24%
Traditional mortgage financing
Swedish mortgage institutions finance their operations mainly by issuing bonds and certificates. The
entire balance sheet of the mortgage institution serves as security for borrowing, and consequently
each loan is not directly linked to a specific amount of collateral.
The advantage of the Swedish model is that borrowing can be undertaken without any fixed link to
specific loans. This means that large loans can be put onto the market, which makes it easier to uphold
regular trade and strong liquidity. This has been the case with the Swedish benchmark bonds. Thanks
to significant lending volumes and strong price formation on domestic loans, the mortgage institutions
have also been able to compete successfully on the international bond market.
Borrowing against the entire balance sheet as security requires significant risk capital or some form of
guarantees from the owners. All mortgage institutions, with the exception of SEB Bolån which does
not does undertake borrowing transactions in foreign currency, have a capital cover considerably
above the statutory minimum of 8% (Figure 9).
Swedish mortgage institutions ́capital
ratios, 1999.
Total Tier 1
NB-Hypotek 10 8,8
SBAB 9,4 6,5
SEB Bolån 8,8 4,8
Spintab 13,5 10,0
Stadshypotek 12,6 12,6
Source: Mortgage institutions ́ annual reports.
The Swedish mortgage institutions are currently estimated to borrow around 20% of their capital from
abroad. The major part of this is borrowed from investors in the USA and Japan. Borrowing in the
euro area accounts for approximately 20% of borrowing abroad. It is difficult to see that the option of
borrowing in euro would increase central European investors' interest in Swedish housing bonds. As
long as Sweden is not a member of EMU and as long as Swedish borrowers want to borrow in
Swedish kronor, the foreign exchange risk will remain.
Increasing competition on the mortgage market will entail a greater need for new forms of financing
that are more economical with the institution's risk capital. Two financing forms being used
increasingly by foreign mortgage institutions are gilt-edged bonds and securitisation.
Gilt-edged bonds
In Denmark and Germany, mortgages are primarily financed through specially regulated secure bonds.
These secure bonds are mainly housing bonds with clearly defined collateral. Security for this type of
bond is regulated by law and the bonds are subject to strict supervision by authorities.
The German and Danish secure bonds have been given special treatment in EU directives. Under this
special treatment, member states can exempt insurance companies and fund companies from the
normal requirements for spreading risk for these bonds and a lower risk weighting can be applied
when calculating capital adequacy requirements.
The government has instigated an investigation into whether gilt-edged bonds could be introduced in
Sweden. In brief, the proposal means that a priority right would apply for this type of bond, that clear
limits would be defined for the collateral ratio (max 75% for residential property) and that collateral
would be identified in a special register controlled by the Swedish Financial Supervisory Authority.
The proposal is currently being examined by the Ministry of Finance.
The main argument in favour of allowing Swedish mortgage institutions to issue gilt-edged bonds is
that such bonds are issued by European competitors and are already established on the market.
Gilt-edged bonds would thereby be easier to sell to investors, would involve higher liquidity and give
lower interest rates than traditional Swedish housing bonds. This would facilitate the mortgage
institutions' financing and would hopefully result in lower interest rates for consumers.
However, the Riksbank is critical towards the proposal on account of the doubtful role that the
national supervisory authority would assume by taking responsibility for ensuing that the total
collateral for the loan is intact. The supervision of Finansinspektionen may create the impression that
the government is assuming special responsibility for the security of the bonds, and this is not the
intention.
Special legislation on gilt-edged bonds is likely to entail a return to tighter market regulation as
mortgage institutions would be granted a special status on the capital market. What economic reason
motivates to show favour to a certain group of borrowers?
It is not obvious that gilt-edged bonds would contribute to reducing the mortgage institutions' total
financing costs. Gilt-edged bonds can only be issued against security up to a certain limit of the
collateral value. It is likely that the remaining stock of non-secured loans will become more expensive
to finance. The use of gilt-edged bonds may lead to lower financing costs for the issuing mortgage
institutions if these institutions do not have to bear the cost of the special supervision that gilt-edged
bonds require.
In my opinion, the increasing competition will promote new forms of funding that make more efficient
use of equity.
Securitisation
One financing form that permits the efficient use of equity is securitisation. Securitisation involves a
given loan stock with accompanying collateral being taken off the balance sheet of the mortgage
institution and sold to a separate company specially created for this purpose (known as a special
purpose vehicle). This separate company is then financed through issuing bonds on the market. The
special purpose vehicle has a clearly defined risk scenario and does not pursue any business activities
other than acting as holder of the specified loans. Consequently, the company is not subject to the
capital adequacy regulations that apply for mortgage institutions.
Securitisation has several advantages, the main one being that it enables mortgage institutions to
reduce their share of equity and thereby their total financing cost, since equity is a more expensive
source of financing than loan financing. Furthermore, mortgage institutions can streamline their
operations by selling claims and by specialising in issuing loans. Securitisation can also increase the
stability of the financial system as credit risks can be transferred from institutions subject to regulation
to players that are less sensitive to heavy credit losses.
Securitisation using a special purpose vehicle located in Sweden is permitted, but in practice it is
unprofitable since, under the current regulations, the special purpose vehicle will be subject to the
same capital adequacy regulations as the mortgage institutions. A proposal to improve the conditions
for securitisation in Sweden is currently being prepared by the Ministry of Finance. The Budget Bill
for 2001 states that the government intends to put forward a bill on improved conditions for
securitisation during autumn 2000.
To date, three Swedish mortgage institutions, SBAB, SEB-Bolån and Bokredit have undertaken
securitisation via special purpose vehicles abroad. On five occasions between 1990 and 1994, SEB
securitised mortgage loans totalling SEK 12 billion, and in June 2000, the same bank securitised
mortgage loans worth approximately SEK 8.5 billion. SBAB securitised mortgages worth
approximately SEK 1 billion in February 2000 and loans worth approximately SEK 8 billion in
October 2000. Bokredit, owned by Den Danske Bank, has securitised a stock of mortgage loans to a
value of SEK 1.3 billion. A new Internet-based issuer of mortgage loans is Europeloan, which started
up operations in Sweden in February 1999. Europeloan is financing their internet based mortgage
lending by securitisation of the loans abroad, up to now around SEK 0,5 billion.
Objections that have been expressed against securitisation include the fact that up until now it has been
relatively complicated and costly to set up special purpose vehicles, and it has not been possible to
invest the bonds at such favourable interest rates as their rating would imply. Possible reasons are that
the market is underdeveloped and the issues have been few, which has meant that liquidity in the
bonds has been low.
Securitisation of mortgages is common in the USA, where around half of the total outstanding loans
stock of secured loans is securitised. In Europe, housing financing has mainly taken other forms. If
competition in the mortgage market increases as a result of EMU, it is likely that the need to finance
mortgage loans as economically as possible will also increase. Taking this into account, it is not
unreasonable to believe that securitisation will become a more attractive option.
Increased competition can thus lead to a growing market for securitisation. Alternatively, the opposite
may apply, ie that improved opportunities for securitisation will increase competition. This is what
happened in Australia, where the mortgage market was deregulated during the 1990s. Legislation
facilitating securitisation reduced the previously high market entry barriers, paved the way for new
players and reduced costs for borrowers by as much as a couple of percentage points.
Conclusion
Overall, most factors point to an increase in competition on the mortgage market. New forms of
financing, new technology and possible EMU participation will contribute to reducing costs for new
players trying to enter the mortgage market. Since mortgages are standardised products, lenders will
compete on price, ie the rate of interest on the loan. The financing issue will therefore be a decisive
one for issuers of mortgages.
Traditionally, mortgage institutions have financed their operations by borrowing using their entire
balance sheet as collateral. This method of financing is relatively expensive for mortgage institutions
and as competition on the mortgage market increases, so will the need for cheaper methods of
financing.
Securitisation and gilt-edged bonds have been discussed as possible methods for mortgage institutions
to reduce their financing costs. Of these two financing methods, securitisation stands out as having the
greatest potential for reducing financing costs, since securitisation makes the most efficient use of
equity.