Following my recommendations in my blog, Positive Financial Sustainability for the City of Manila last January 20, 2014. I recommended, that we may also take into consideration Issuing “Development Bonds”.
Bonds, can be is defined as, a debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.
Development Bonds for the City of Manila, could be like that of the successful, impressive and brilliant innovation on the use of an investment vehicle for raising capital is the “PABAHAY BONDS”. These Bonds, was issued by the NHMFC, headed by Vice President Binay.
The president of National Home Mortgage Finance Corporation is Dr. Felixberto U.Bustos Jr. a Finance Genius, engineered the “ PABAHAY BONDS” In his presentation during the general investors’ briefing at the Grand Men Seng Hotel Davao, NHMFC president Felixberto Bustos Jr. said the Bahay Bonds 2 allows investors, including low-income individuals, to invest a principal amount for as low as P5,000 with a tax free interest rate of 4.80 percent per annum. The proceeds that will be collected from the invertors will be used to sustain the NHMPC’s housing loans, as the government’s major secondary mortgage institution in attracting long term funds to provide strong and sustainable housing finance.
The investments also will be used to purchase additional housing receivables from public and housing lenders.
The Bahay Bonds project was first launched on March 23, 2009, with only three primary investors, including Rizal Commercial Backing Corporation, Banco de Oro, and the LBP. The total investments reached P2.06 billion.
However, we need to give credit to the Vice President for Operations and Securitizations of the at National Home Mortgage Finance Corporation and President and Executive Director for the Real Estate Research Foundation, Ms. Daisy Dulay who is an expert, in securitization. Ms. Dulay, the person responsible and the one who worked on the details of the “PABAHAY BONDS”.
After my meeting last week with the authority in securitization, Ms. Daisy Dulay, I asked her to allow me to share with you her research paper she wrote with Marife Ballesteros on Strengthening Mortgage-Backed Securitization in the Philippines: The Role of the Natonal Housing Mortgage Finance Corporation.
Ms. Daisy Dulay and Marife Ballesteros, Senior Research Fellow at Philippine Institute for Development Studies wrote and authored the background study behind Securitization in the Philippina Policy Note in 2013 as follows:
With stricter risk management for banks and financial institutions and the need to address the housing gap of nearly 3.0 million units annually, strategies that will provide long=term funds and expand home finance specifically to the low and moderate income households are essential to ensure the sustainability of housing finance. One potential option is to develop mortgage-backed securitization (MBS) to strengthen the private securities market and the capital market. So far, the Philippine mortgage loans-to-GDP ratio is only about 10 percent, which is considered small based on standards of existing mortgage systems. In advanced economies, housing mortgage depth is between 30 and 75 %
The objective of this Policy Note discusses the role of the National Home Mortgage Finance Corporation (NHMFC) in developing securitization in the country. The NHMFC is the major government corporation created to operate as a secondary mortgage institution but this mandate has not been fully implemented in the past 30 years as NHMFC operations have been diverted to loan origination. With the approval of the Securitization Act of 2004 and improvements in the financial sector, opportunities to engage in securitization have opened up. The NHMFC has taken this opportunity to undertake securitization as a strategy to expand home finance.
In 2007, NHMFC laid the building blocks for its transformation into a secondary Mortgage Institution (SMI). Streamlining the organization from an 850 plantilla organization down to a lean and mean 300; training and gearing of its internal systems and processes for secondary mortgage operations, started the change process which enabled the Corporation to issue its maiden securitization in 2009. The maiden offering was a success and twice oversubscribed. The maiden securitization issue of the NHMC earned for its “Best Securitization Deal for 2009” Award given by the Asian Asset Magazine in January 2010 in Hong Kong. In 2012, NHMFC offered its first retail and publicly listed MBS in the country. The same issue was awarded the “Most Innovative Award” in 2012 by the Philippine Dealing Exchange in Manila.
Framework for a good securitization process
Securitization is the process of legally isolating existing asset pools or future-generated assets away from the company originating the receivables. The process of securitization may be characterized by the following:
Separate or spin-off some of the assets from the company so that they can stand by themselves
The separate assets (together with their identifiable future cash flow streams) are now transformed into marketable securities.
Securities can be sold for cash, with the cash, the originators can now lend again to new borrowers.
In particular, the key factors for the Secondary Mortgage Institution (SMI) such as NHMFC to function efficiently are: (1) initial capital; (2) extraction rate; and (3) turnover rate.
- FUNDING or SMI Capital refers to the equity capital infusion necessary for the SMI to undertake and grow its business. The funds will be utilized to meet start-up costs and operational activities. The initial capitalization requirement should be substantial, given the role of the SMI as a central refinancing platform. The U.S. Federal Home Loan Mortgage Corporation (Freddie Mac) was provided initial funding of US$ 100 million while Hong Kong Mortgage Corporation had an authorized capital of HK$ 3.0 Billion. Ideally, a liquidity facility would be a stand-alone institution but its long-term future should be with the private sector.
- EXTRACTION RATE- Extraction rate is the amount or value that has been generated from a securitization transaction less the value of the junior/subordinated bonds any and all transaction or friction costs. Generally, these are the funds that can be readily utilized for future/subsequent securitizations. Extraction rate is not the same as recovery rate and should not be understand with losses. Extraction rate/fund grows overtime (subject to the performance of the asset pool) and ensures sustainability in housing finance. It is computed by dividing the initial net proceeds by portfolio size.
The extraction rate is affected by: (a) the supply of securitizable accounts (or the asset pool); (b) the quality of the asset pool/accounts; and (c) the creation/availability of investors, particularly the development of a professional market for subordinate tranches.
In essence, the higher the higher the extraction rate is, the better the quality of the asset pool.
- LEVERAGE- is the ability of the SMI to use its securitized instruments or its operations as a support mechanism for financial capital to ensure continuous liquidity in the market (to the investing public). This necessitates the existence or development of the following: (a) Faster Due Diligence Processes (which include the presence of standardized and simplified forms for borrowers, originators, and lending institutions alike) and (b) streamlined review and due diligence processes for the lending institutions. The aforementioned measures would ensure the quality of the assets/mortgages originated and included in the asset pool for securitization. Other processes that are essential include the Sharing of Credit Files, and Standardization and sharing of Valuation Parameters/Standards and Data.
Aside from these factors, securitization would need a partnering arrangement whereby the SMI provides for a risk-sharing approach with banks and other institutions in all the securitization activities going on. This implies that any and all issuances should be rated investment-grade and of low risk and provides for a stable yield.
NHMFC Securitization Experience
The current regime of low interest rates and the improvements in the capital market in the country provided an opportunity for the NHMFC to undertake securitization using residential mortgage loans originated by the agency under UHLP program. In particular, the current low interest rates, afforded NHMFC excess spread. Average interest rates on NHMFC originated loans during the period 1987 to 1996 were highly subsidized with a weighted average rate of 12% compared to the market rates of 16% to 24% in the same period. Currently, interest rate range from 4% to 8%, which provides the environment for NHMFC to convert UHLP mortgages into bonds or notes that can be traded in the open market.
Below are details of the NHMC securitization process.
- NHMFC Bahay Bonds
Between 2009 and 2012, NHMFC has undertaken two securitization issues called Bahay Bonds1 (BB1) and Bahay Bonds 2 (BB2). BB1 represents NHMFC’s maiden securitization issue. This issue is valued at PHP 2.06 B backed by more than 12,000 prime residential mortgage loans, which are the best quality loans in NHMFC’s portfolio. These loans have not been restructured and loan payments were consistently up to date with a collection efficiency rate at the time of issue of about 98%. BB1 was offered only to institutional investors (mainly banks).
BB2 was issued in 2010. The bonds are valued at about PHP 604 million backed by more than 4,000 current and restructured NHMFC UHLP accounts. Compared to BB1, BB2 was offered to the general public. This was the first retail ABS (denominated at PHP 5,000) offered and listed at the Philippine Dealing Exchange (PDEX).
NHMFC has provided several risk-mitigating mechanisms to ensure the protection of investors from potential defaults. These are:
- Tranching or a subordination structure. The subordination structure effectively provides an overcollateralization of the issue. There are two classes of BB1 notes: (a) Senior Notes rated AA by BSP accredited rating company, PhilRatings; (b) Sub-Notes, rated BBB+ by PhilRatings, which have not been sold to the public and retained by NHMFC. Senior Notes have the first priority in payments and, in cases of defaults or prepayments, senior notes will be the last to be affected.
On the other hand, BB2 consists of three (3) tranches: (a) Senior Note A sold to the public (b) Senior Note B sold to institutional investors. Both Senior Notes were rated by PhilRatings as AA; and (c) Subordinated Notes held by NHMFC rated BBB+ by PhilRatings.
- Liquidity reserves equivalent to nine months of what is due the senior note holders.
- Commingled reserves equivalent to three months of what is due the senior note holders.
- Provision of a sovereign guarantee through the Home Guarantee Corporation (HGC) on timely payment of loans. The HGC provides a guarantee in the form of debentures in case of default on the installment payments. The debentures shall pay the full principal component of the expected installment plus interest component of up to 11% p.a. of the defaulted assets that are allocated to Senior Notes. HGC Guaranty does not cover losses of the assets allocated to Subordinated Notes.
- Creation of a Seller Restricted account (which comprises all the excess spread due the Sub-Note Holder/NHMFC) that is not released to NHMFC until the Senior Note Holders are fully paid. This account is technically a Sinking Fund that provides an added layer of security to the Senior Note Holders. The sinking fund was created specifically for BB2 due to the lower quality of assets in the pool (i.e., some mortgages were restructured).
- Transaction Cost and Extraction Rate
A key issue in the development of MBS in the country is the high execution cost of this undertaking. The cost consists of one-time fees (or fixed costs) and recurring costs. Using the NHMFC experience, MBS execution costs amounted to a total of 5.96 % and 4.89% of the portfolio amount for BB1 and BB2, respectively. The upfront cost (or fixed cost) for BB1 and BB2 is higher at 4.3.7% based on issue size due to the smaller value of BB2 issue compared to BB1.
In both MBS transactions, NHMFC allocated funds for reserves (liquidity, commingled reserves, sinking fund) as an added layer of security. The combined expenses or costs of the securitization process amount to about 18 % of the portfolio size for BB1 and about 20 % for BB2. This provides an extraction rate of only 70%. However, reserves are considered reflows, which eventually go back to the funds. The greater concern in securitization is to reduce the operating costs to increase the extraction rate.
NHMFC expects that as it continues with its securitization activities, the above costs should go down. It is important to note that the high transaction or friction cost (particularly for the BB1 issue) is both a function of a learning cycle and legal requirements. Since the transaction is a maiden issue, the NHMFC endeavored to follow the plain vanilla structure to the letter and be fully compliant with the Securitization Law of 2004. As it fully matures, it envisions that certain friction costs may be reduced further as it can perform the same without the need for other third parties r that templates may be developed and standardized to further lessen transaction costs.
Generally, the perception of high risk is associated with the MBS and this is evident from the regulation and controls provided by the BSP and Insurance Commission in the investment of banks and insurance companies in MBS. The BSP further limited bank investments in MBS unless with a sovereign guarantee. Likewise, MBS is not in the list of automatically admitted assets eligible for purchase by insurance companies. Investment in MBS requires prior approval from the Insurance Commission. This was done for BB1.
The Bahay Bonds II Special Purpose Trust joins the growing issuer community of PDEx and brings the year-to-date new corporate and bank debt listings to P98.15 billion, and the total level of tradable corporate and bank debt instruments to P273.53 billion issued by 17 companies with 46 securities. Carrying the sovereign guaranty of the Republic of the Philippines, the Bahay Bonds II Class A Senior Notes are guaranteed by the Home Guaranty Corporation and bear a 4.8% interest rate which makes the bonds higher than most interest rate on bank deposits. They are designed to be safe, high yielding, and affordable savings instruments fitted for the appetite of retail investors. Philippine Ratings Services Corp. (PRS) assigned a PRS Aa Rating for Class A Senior Notes, reflecting a high quality instrument with very low credit risk. Proceeds of the Bahay Bonds II debt sale will be used by NHMFC to purchase more housing loans to provide the lending firms with liquidity and provide more loans to their clients.
Tomorrow we shall continue by showing what must be done to keep the momentum going.