Thursday, January 16, the Governor of the Cream Bank Mr. Noeh Cas, revived the idea of securitization of home loans, in a letter of greetings to the attention of bankers. This announcement will not delight consumer associations, as it would automatically lead to an increase in borrowing rates. To understand why and how, let’s see what securitization consists of, and what are the means to delay its negative effects on the consumer.
What is securitization?
Purchase of receivables
Securitization is nothing more or less than a repurchase of receivables. In the context of home loans, the bank or the credit company that granted them may resell its claims to a financial company, which will buy them by raising private funds. The configuration is therefore close to factoring, namely that a company can resell its claims to a bank, in order to receive funds immediately.
The argument on the need for securitization of home loans
When a bank lends property investors and first-time buyers, it therefore pays itself on the interest received. However, the loaned capital is then unavailable until it is fully repaid. The bank may have better investments to make. She would then be tempted to borrow from other banks, using the repayments of the home loans she granted, to repay this new loan which will be used to invest her.
This scheme has been used for a long time, it led to most of the stock market crashes and in particular to that of subprimes in 2008.
To prevent this kind of systemic crisis from happening again, the Basel agreements require that from 2019, banks’ capital represent 7% of their commitments in “hard capital”. Clearly, banks will no longer be able to borrow excessively to repay.
But this security will have a major drawback. Banks will also have less capital to lend to businesses, and therefore to start the economy. Hence the idea of securitizing home loans, in order to give them capital.
The mechanism of securitization of home loans
Suppose that a bank needs capital for other investments. The bank determines the number of mortgages it could resell in order to obtain cash. Once this calculation has been made, it instructs a Mutual Receivable Fund to seek investors to buy back its mortgage loans.
The fund is aimed at other funds, attracted by the certainty of this investment. Payment defaults in the context of real estate loans are rare, because it is always possible to restructure the debt, due to the presence of real estate in mortgage.
The fund pays the bank with the proceeds from the sale of the bonds, and the bank thus has capital to invest. Individuals will not see the difference because their monthly payments will not move us, unless it is a variable rate, and again the variation will only be based on the benchmark index.
On the side of individuals, nothing changes except that the interest they pay will remunerate investors. Of course this is a largely simplified explanation, in reality the legal and financial mechanisms are much more complicated.
Securitization of home loans, borrower side
Probable rate hike
The process of securitization of real estate loans implies the intervention of a common loan fund and of investors. All these protagonists must be remunerated enough to provoke their intervention. This need to remunerate them means that the sum that will be remitted to the bank that securitized its property claims will be less than the capital that it would have recovered without securitization.
To understand this, let’s compare this principle with that of factoring. A business has a claim, but it needs the amount owed immediately. She therefore remits this claim to a bank, which buys it back for 90% of its price. The company will therefore collect 90% of the sums due, less costs, which represents a shortfall.
To anticipate this loss, it makes sense for the bank to take a certain margin of safety on the mortgage loan rates it grants. This logic is of course far from satisfying consumer associations, and borrowers themselves.
For example, the site of the Le Figaro newspaper announces on its site that, according to an analyst, French securitizations bring in up to 20 points less than Dutch securitizations. The reason: the low current mortgage loan rates.
Need to delay rate hikes
The transfer of banking risks to the borrower is not up to date in France or in the European Union. Experts are already highlighting the fact that many factors are involved, and that it will be possible to delay the rise in rates. We are putting forward, for example, the implementation of good practices, in order to avoid banks taking advantage of the securitization of mortgage loans to exaggerate the rise in rates. The first precaution will be to limit the volume of securitization.
Up to 25% maximum volume
For the moment, specialists suggest that the securitization of mortgage loans should not concern more than 25% of the volume. Le Figaro cites figures from the Moody agency, which specifies that securitization operations represent only 4 billion USD in France. It is obvious that the inevitable rise in mortgage rates will be all the more marked as the volume of securitization is high.
Long debates in perspective
At this point it is important to note that nothing has been done yet, and that a lot of ink will have flowed before the practice of securitization is widespread in France.
Because we know the impact of mortgage rates on the housing market. When rates go up, the purchasing power of first-time buyers and investors decreases. If this purchasing power decreases, it is not only the construction sector which suffers, but also the banking sector itself.
It will therefore take a great deal of caution so that securitization of home loans does not turn into a dog that bites its tail.