European Mortgage Bonds and MBS.

• Author: Franscini, Mathilde
• Position: Mortgage backed securities

Issuing mortgage bonds into the capital market is a major specialized method to fund mortgage loans in Europe. However, the development of this capital market instrument has not been even throughout Europe and the importance of the mortgage bonds as funding instrument varies widely among countries.

MBS is not yet a widely spread funding instrument in Europe as it is in the United States. However, when we take a closer look on the country level, we notice many differences in terms of its importance as a funding instrument. United Kingdom is the largest MBS market in the EU.

1. EUROPEAN MORTGAGE BONDS: OVERVIEW

   1. Market Development

      1. European importance

         Mortgage bonds were first issued over 200 years ago in Germany and have subsequently developed in other parts of Europe most notably in Denmark, Sweden Austria, France and Spain. Today, the mortgage bond has established itself as one of the dominant components of the European bond market. The volume of mortgage bonds outstanding in the EU exceeded EUR 1.3 tn--18% of total domestic debt securities outstanding in the EU--at the end of 1999.

      2. Concentration

         The mortgage bond market in Europe is highly concentrated. As mentioned earlier, three countries share more than 85% of the overall mortgage bond market. Germany leads with 44% of the volume outstanding, followed by Denmark with 29% and Sweden with 15%. The remainder of the market is shared between Spain, France, Austria, Netherlands, Portugal, Finland and Norway.

         In Denmark, mortgage lending by mortgage banks is fully funded through the issue of mortgage bonds. For Sweden, mortgage bonds, representing about 70% of total funding for the housing credit institutions, constitute the leading source of financing. The system is further strongly established in Germany and Austria. The German "Hypotheken-Pfandbrief" market, amounting to EUR 232 bn (mid-1999), is one of the largest fixed-income market in Europe. Mortgage bonds constitute the second source of financing in France and Spain, but represent only 17% and 6% respectively of the total mortgage funding well behind deposits. In the Netherlands and Norway, mortgage bonds are issued but fund a relatively small part of the loans (7% and 1% respectively).

         Of all the newly established systems, those of Spain and more specifically France are felt to have the greatest potential of becoming a liquid market segment. On the one hand, the new French system, like that in Luxembourg, sticks relatively closely to the German system in many aspects and defines safety, features for its bonds that are comparable to those of the German Pfandbrief. On the other hand, Spanish Cedulas Hipotecarias, which can only be issued as mortgage-secured bonds, differ much more from the German version in terms of the legal framework.

      3. Public mortgage bonds

         In a number of European countries, mortgage bonds are also used to fund loans to the public sector. The bonds are referred to as "public mortgage bonds" and are as well subject to restrictive laws. Public mortgage bonds are widely used in Germany and Austria where public sector loans constitute nowadays the dominant collateral for mortgage bonds. Public mortgage bonds are also issued in France and Luxembourg.

      4. Drivers for growth

         The introduction of the Euro has created a strong incentive for the development of mortgage bond markets in Europe. Historically, low nominal interest rates have given rise to an environment that pushes mortgage lenders to adjust their methods of funding. The high demand for mortgages, coupled with low interest rates on deposits, raises questions over the continued ability of lenders to finance mortgages primarily through retail funds. At the same time, the elimination of exchange rate risk in the Euro area and the initiative undertaken by the European Commission to create a deep and liquid European capital market are encouraging many lenders to put greater emphasis on the wholesale markets as an alternative method for funding mortgage loans.

         The strong growth ha the European mortgage bond markets in the last few years has been accompanied by massive changes in the rules governing the issue of those bonds. Some countries "re-activated" the use of mortgage bonds (France and Spain) while some others introduced a mortgage bond law (Luxembourg and Finland).

   2. Legal Framework

      1. At the International level

         The Basel Accord is spearheading the banking reforms, notably stricter and more evenly applied capital adequacy requirements, which, in turn, will make it much more expensive for banks in several countries to hold loans on their balance...