Second Stage in the Securitization of Home Loans
July 2 (Monday) 2007
Hidetaka Yoneyama
Research Fellow
Summary
- The “Flat 35”, a long-term fixed interest home loan provided by the Japan Housing Finance Agency’s (formerly the Government Housing Loan Corporation) securitization support program, got off to a sluggish start when it was first introduced in October 2003. Since the end of 2004, however, it has seen rapid growth, and currently over 130,000 houses are being managed. “Flat 35” refers to a system where government-affiliated financial corporations buy out home loans from private financial organizations. Mortgage-Backed Securities (MBS) are then issued with these home loans as collateral, and funds are raised by selling these securities to investors.
Management of the Rapidly Increasing “Flat 35”
The “Flat 35” interest rate is derived from the interest payments to investors, the operation expenses of the government-affiliated financial corporations, and the commission charged by the private financial organizations. In the “Flat 35” program, low-interest MBSs are issued using high credit ratings; these ratings are derived from the holding assets of the agency. Moreover, as various financial organizations participate the commission rates drop as a result of competition, and it becomes possible to provide low-interest home loans.
The number of financial organizations currently managing “Flat 35s” has reached about 320. A new “mortgage bank” type of business has also emerged where, unlike normal financial organizations, deposits are not collected, and instead home loans are sold exclusively to government-affiliated financial corporations (recently this kind of business represents half of the total of houses managed).
In terms of risks related to home loans, there are trust risks (default risks), pre-payment risks (the risk of pre-term repayment due to lump payments made when refinancing, moving and etc.), interest risks, and liquidity risks. In the “Flat 35” system, the agency bears the trust and liquidity risks while investors bear the interest and pre-payment risks.
For financial organizations, the “Flat 35” system has the merits of making it possible to provide long-term fixed interest loans without bearing these risks. With this it becomes possible to create an off-balance in assets and debt, and there is the merit of bringing in commission without increasing assets or debt. With regards to investors, for entities that conduct very long-term management such as social security and insurance, there is the merit of gaining attractive investment targets. Moreover, for home loan borrowers, the merit of being able to borrow long-term fixed interest home loans goes without saying.
In this way, the expanding securitization market has brought about merits for various parties. To create further growth, it is necessary to improve convenience for loan borrowers as well as make it more attractive to investors. The Government Housing Loan Corporation became the Japan Housing Finance Agency in April 2007, and this agency has brought about a second stage in the development of the securitization market by endeavoring even more seriously with its securitization support programs. However, there are more issues that must be resolved.
Improving Convenience for Home Loan Borrowers
The following are issues in improving convenience for loan borrowers. First, the current Flat 35 system is limited to acquiring long-term fixed interest home loans of up to 35 years. The needs of loan borrowers, however, are varied (if a lump payment of retirement benefits were expected, then the fixed interest period would be preferred at around 20 years, and so on). In the future, it would be desirable to introduce loans with a premise of even shorter repayment terms (regarding this, the introduction of home loans with a borrowing period of up to 20 years is currently being considered).
In addition, interest for Flat 35 is applied at the time the loan is issued, not when the loan is applied for. In times of rising interest rates, therefore, borrowers are subject to the risk of a higher interest rate when the loan is issued than when the loan was applied for. Regarding this, a format where loan borrowers could pay a certain fee to have the interest rate fixed beforehand should be considered. For example, it would be possible to issue the loan when construction of the house is completed, but the interest would be fixed beforehand, and since the agency covers the risk the MBS would be issued when construction begins with a fixed interest rate (proposal of the advisory council concerning the housing financial market). Loan borrowers would pay the equivalent of the MBA interest during the interest-lock period (from beginning to completion of construction) in the form of commission. By doing so, it will produce the same effect as receiving the issued loan when construction commences with a fixed interest rate.
Improving Convenience for Investors
The following are issues in improving convenience for investors. For very long-term management entities such as pension and insurance, MBSs are favorable targets for asset management. Investors, however, do not necessarily need the entire MBS cash flow. For example, if short-term pension and insurance payments are appropriated from other financial products such as corporate bonds, and mid-term payments are assumed to be covered by MBSs, then the short-term MBS cash flow should be excluded from investment targets. Collateralized Mortgage Obligation (CMO) responds to such a need. CMOs are re-securitized products made by modifying and adapting to investors’ preferences regarding the MBS cash flow.
Setting up CMOs has the merit of being able to take one financial product and divide it into multiple parts, and if each part fulfills a need, in total they can sell for a higher amount. In the US, organizations promoting securitization are supporting private re-securitization, and in the future the Japan Housing Finance Agency should provide similar support.