Mortgage Bondcovered bond
UBS AG recently concluded a contract with the Schweizerische Pfandbriefbank (Pfandbriefbank) to issue a CHF 2 billion worth of bonds to three domestic consumer credit unions in Switzerland. This is the first time that such a large amount of Pfandbriefe has been sold, in which only three major credit institutes have raised the funds from the issue of Pfandbriefe and the revenues from such transactions have been used for credit transactions with only one particular member state.
At the end of spring 2007, the turmoil in the lending markets began forcing Austrian Post's banking sector to establish new funding structure for loan portfolio funding and provide investors with easy and secure cashflow. For example, they are trying to use alternate forms. First, and above all, they have jumped into the breach and are providing cash flow facility against assets that would otherwise be iliquid.
Instead of reselling distressed asset values to an investor, some government and CBs have launched programs in which such asset values have been purchased and converted into "off-balance sheets " in order to provide the bank with cash and separate the distressed asset from the bank's accounts. In addition, regulatory and operating restrictions can make the assignment of large mortgage loan portfolio somewhat burdensome and time-consuming as, according to the selected regulatory certainty framework, a large number of single mortgages have to be insulated and assigned in order to perfection the deposit principle.
Recently, two deals with major Suisse financial institutions were recently confirmed. A transaction was completed in Switzerland in May 2008, in which UBS AG divested a mortgage loan portfolio to Black Rock for a previously disclosed aggregate consideration of USD 15 billion. Funding for the pooled business was provided by USD 3.75 billion of capital raising from Black Rock's investor base and a USD 11.25 billion secure loan provided by UBS AG.
Secondly, the exposure weight of the Black Rock collateralised credit is less serious than the exposure weight of the mortgage credit pools. In the summer of 2008, a second transaction was heralded in which Credit Suisse sold a mortgage credit book to GE Estate, a small number of large mortgage credits that were passed on to high-quality borrower and backed by properties in the UK, Germany, Spain and Switzerland.
Creation of ABSs suitable as security for CBs In light of the pressure on the short-term refinancing market, various SNBs (such as the Federal Reserve, the European Central Bank and the Swiss National Bank ) have launched cash flow programs in which collateralized short-term credit lines are granted to them. Our objective was to give bank investors easy recourse to cash for collaterals that would otherwise not be available under conditions of uncollateralised inter-bank market tension.
In this way, the programs offer bankers an alternate means of providing cash. Accordingly, many asset-backed securities (ABS) trades, including some using Switzerland's own funds, have been designed and constructed to produce UBS note products that satisfy the admission requirements of the respective SNB. These banknotes are produced even if it is not immediately necessary to deal with the central banks with these banknotes.
It is preferable for bankers to make sure that, in the absence of sufficient cash, they have ABSs that are more solvent than the underlyings. Ever since the introduction of such programs, the Swiss Federal Reserve (in particular the European Bank, but also the Swiss Federal Reserve) has significantly increased its cash flow. Selling credit portfolio to public sector entities or to entities supported by public sector entities or public sector banksA further resource of solvency has been made available to banking institutions through the development of public sector or domestic bank-based entities to which problematic asset items have been assigned.
The UBS AG and the Swiss National Bank established a SPV (Special-Purpose Vehicle ), which was financed with CHF 6 billion of own capital (provided by the UBS AG, which borrowed these resources by the issue of a compulsory exchangeable bond to the Swiss Confederation) and debts of the Swiss National Bank, and purchased a whole bank of problem property from UBS.
UBS AG has recently concluded a contract with the Zürcher Kantonalbank, the Raiffeisen Group and Postfinance to raise approximately CHF 2 billion. All three banks are mainly operating in the home markets of Switzerland and are less affected by the financial crunch than international companies. Funding was provided by the three creditors by underwriting Pfandbriefe from the Pfandbrief Banks in Switzerland and by the UBS AG, which disbursed the borrowed capital against Mortgage Pfandbriefe.
For example, the transactions within the scope of the Pfandbrief system in Switzerland were carried out in accordance with the provisions of the Pfandbrief Act in order to simplify the transactions and enhance the safety packet analyses. Nevertheless, the Pfandbrief system in Switzerland has never been used to carry out a particular type of operation in order to allow a very small number of borrowers to borrow money from a particular debtor.
Rather, the operation under which institutes provide funding from the Pfandbrief bank or the mortgage bank of the Kantonalbanken and the operations under which the investor subscribes Pfandbriefe are usually not organised as a separate operation but rather co-ordinated to secure consistency between interest rates and conditions. Nevertheless, this operation shows that the Pfandbrief system can be used as a fundraising vehicle in exceptional conditions, as it offers a stable and secure system that can potentially draw in other prospective creditors.
Pfandbrief system The Pfandbrief system was established in 1930 and is generally governed by the Pfandbrief Act (1930) and the corresponding Pfandbrief legislation of January (1931). This Act repeals the general regulations of the Swiss Code of Obligations and the Federal Act on Debt Collection and Bankruptcy.
Pfandbriefe are emitted to private equity holders as part of the Pfandbrief system. Subsequently, the Pfandbrief agents borrow the proceeds in this way and lend them to the member institutions against mortgage collateral (consisting of mortgage loans). The system thus enables the member bank to fund its mortgage financing activities. Pfandbriefe are collateralised bond-like instruments and are (indirectly) fully collateralised by land in Switzerland.
Basically, the covered bond system consists of four main players. Participants in the Mortgage Bond system are: Mortgage bond agents; member credit cooperatives; institutional clients. Mortgage bond agents emit mortgage bonds to private individuals and loan the proceeds on a secure footing to their member bank. According to the German Mortgage Bond Act, only two institutes are entitled to issued Mortgage Bonds:
i) the Pfandbrief central office - established and owned by the Schweizer Kantonalbanken and established in 1931; and ii) the Pfandbrief central office - established and owned by the Schweizer Nicht-Kantonalbanken, also established in 1931. Kantonalbanken are members and stockholders of the Pfandbrief Central Office, while non-cantonalbanks are members and stockholders of the Schweizer Pfandbriefbank.
The two Pfandbrief bureaus have been approved by the Federal Council and are monitored by the Financial Market Authority. They do not have a general bank licence but, under the Pfandbrief Act, they are only authorised to grant Pfandbriefe, to either grant the proceeds of Pfandbriefe to their member bank members (on a secure and relatively advantageous basis) or to non-member bank members (on a secure but less advantageous condition and subject to more stringent admission requirements in relation to the security pool) and to engage in all types of bank operations necessary to assist in the above work.
The member bank may lend money from the respective Pfandbriefagentur. These credits correspond to a specific Pfandbrief issuance by the respective Pfandbriefagentur. Credits to member institutions must be secured by mortgage credit (and related mortgage collateral) provided by member institutions to their customers (mortgage debtors).
Provided that it is properly registered, the collateral is formed by the Act on the respective mortgage loan pools. Pursuant to Article 3 of the Pfandbrief Act, SNBs may become members of the Pfandbrief Central Office. is domiciled in Switzerland and (ii) at least 60% of its total asset value consists of mortgage borrowings in Switzerland.
Derogations may be allowed with respect to the second condition. Every domiciled in Switzerland whose mortgage credit in Switzerland accounts for at least 10% of its total assets can become a member. Non-resident institutions are not allowed to become member institutions and therefore have no right of entry into the Pfandbrief system.
The majority of Swiss registered bankers with their headquarters in Switzerland are members and therefore have full system account. Pfandbriefbank has around 240 member bankers. Mortgage loans provided by a member borrower to a mortgage creditor are the final assets that can be funded through the Swiss Pfandbrief system.
It contains stringent admission conditions for mortgage lending and the mortgage collateral on which it is based. Every Pfandbrief owner is - by operation of statute - protected by credits which the Pfandbrief Agent grants to its member institutions, and these credits are in turn protected by the collateral fund. Not only does the Pfandbrief Act create a statutory right of lien (no collateral arrangement and no collateral packages have to be transferred), it also contains statutory minima for the collateral pools.
Accordingly, the Pfandbrief issuer profits from a robust and prudent safety precaution. Mortgage bonds are finally backed by mortgage collateral, which secures the mortgage credits extended by the member bank to the mortgage debtor. Under the Pfandbrief Act, the collateral protection system is defined as follows: Issuers of Pfandbriefe have a right of collateral for all credit facilities provided to their member bank by the respective Pfandbriefagentur.
No collateral arrangement or assignment of any document or collateral would be necessary to duly establish the collateral right provided that the collateral pools' holdings are duly registered. Credits extended by the Pfandbrief Agent to a member are legally protected by a guaranteed interest rate on the mortgage credit (and the associated mortgage security) that the member grants to its mortgage creditor.
No collateral arrangement or assignment of any document or collateral would be required to duly establish the interest provided that the collateral pools' holdings are duly registered. Mortgages extended by member bankers to mortgage creditors must be collateralised by mortgages on properties situated in Switzerland.
Minimum Pfandbrief Act regulations are the minimum requirement for the collateral fund. Any Pfandbrief agent may establish more stringent policies (and both have done so). Since, however, the regulations for the collateral fund provided by law are stringent and conservative, these regulations are the core of the Pfandbrief's character.
Lendings made available by Pfandbrief brokers to their member bankers, as well as interest on them, must be secured by chargeable mortgage credits amounting to at least 100% of the lending. In the event that the overall interest rates of the mortgage credits included in the coverage pools are lower than the interest to be disbursed for the credit, the security deposit must be raised to compensate for the possible deficit.
The two Pfandbrief bureaus raised their capital and interest cover ratios. Mortgage credits must be guaranteed by properties situated in Switzerland (or Pfandbriefe meeting all criteria). One of the most important features of the Pfandbrief system's dependability is the loan-to-value ratios (LTVs) provided for investor security by law.
Pursuant to section 34(2), the LTV of mortgage lending may not exeed two third of the current value. Covered bond agents may, at their discretion, prescribe more stringent terms for the LTV ( e.g. the Covered Bond issuer charges half the LTV for business properties and vacation homes). Mortgages and thus also mortgage collateral are always kept by the respective member banks.
That can make the procedure considerably easier (except in the context of secure funding or funding outside the Pfandbrief system). It is an important part of the system as the mortgage loan and the collateral for it can be served by the member banks themselves with ease.
Otherwise, service provision outsourced could become a problem in terms of bank confidentiality, outsourced service provision regulations and privacy, unless any mortgage creditor has an exemption. The Pfandbrief agency as well as the member bank must keep a securities registry in which each mortgage credit as well as further mortgage securities related issues (especially properties) are recorded.
Mortgage Bond Act Ordinance details all information that must be entered in such registries. Under the Pfandbrief Act, it is a constitutional obligation of the collateral right that collateral securities be duly recorded. There is no collateral right if the collateral values are not recorded.
The collateral pools provided by the member institutions may be dynamically. Thus, it is possible to withdraw asset from the pooled and add other asset. In the event that the inflow of funds derived from the Pfandbrief Fund ing pools (i.e. above all the interest payments) is lower than the interest payable on the loans provided by the Pfandbrief Bank, the Pfandbrief Fund must be raised accordingly.
The member banks can make available temporary liquid funds or negotiable federal, cantonal or municipal securities to fill the coverage gap. Those borrowings must be rated at 95% of their listed strike value. In addition, according to the provisions enacted by the Pfandbriefbank, endangered credits or non-performing credits must be replaced.
This law contains certain evaluation rules to be observed by the Pfandbrief agency. Mortgage bond rating processes by Pfandbrief rating agents and member institutions are overseen and controlled by the Financial Market Authority. There are no regulations in the law that allow Pfandbrief agents to conclude derivative contracts. Hedging is not necessary, however, as the credits and Pfandbriefe must be issued in CHF.
Requiring that a number of Pfandbriefe correspond to the credits extended to member institutions (e.g. in terms of maturity and interest rates) significantly reduce the need for interest hedges. Mortgage bond agents and in particular the collateral fund are examined by specialist examiners and the procedure is supervised by the authorities.
Members (and thus shareholders) of the Pfandbriefbank may only become bankers domiciled in Switzerland. Thus, no non-resident bank has direct or indirect right of entry into the Pfandbrief system. Pursuant to Section 26 of the Act, credits may be extended to non-member credit institutions. The system is not the same for non-member countries. Firstly, the bank must offer security amounting to 105% of the credit taken out.
Secondly, the lien cannot be established by entering the collateral pools asset in the relevant register (except in the case of loans to member banks), but by mortgaging the asset in accordance with the general rules of the Civil Code. Consequently, the creation of a safety interest is more complex from a hands-on point of View.
It seems that the possibility of lending money to non-member countries is just not workable. In addition, according to the Pfandbriefbank's own rules, credits to non-member institutions are only extended in exceptional cases. It is, for example, reasonable to extend credit to non-member countries, which will soon become members.
As far as the Pfandbrief head office is concerned, the membership is restricted to the Kantonalbanken. In terms of the leveraging effect of the member bank, the general regulatory conditions of the Pfandbrief system are cautious. To this extent, Moody's continues to rate the Pfandbriefe it issues from the Pfandbrief agents as having value equivalent to zero (Aaa). There is no borrower credit assessment, but only for Pfandbriefe emitted by the Pfandbriefbank.
" Unlike most asset-backed securities issuances (e.g. resident mortgage-backed bonds (RMBS) and commercial mortgage-backed bonds (CMBS)), the issuance of Pfandbriefe (and any other Pfandbriefe) is a traditional on-balance-sheet credit business, i.e. the corresponding asset items are retained on the member banks' and Pfandbrief headquarters' books.
Whilst the restricted regulatory requirement is characteristic for asset-backed securities (ABS), asset-backed securities (RMBS) and asset-backed securities (CMBS) trades, the Pfandbrief issuer is not only protected by the collateral fund, but also has full rights of recovery both with the responsible Pfandbrief agent (directly) and with the member bank (indirectly). Thus, in situations where the collateral pools would not be able to provide Pfandbriefe coverage (a situation that has not yet occurred), the Pfandbrief investors could experience a complete setback.
As a rule, there are no further creditworthiness improvement functions in the Pfandbrief system. As a rule, there is no need for liquid funds institutions and similar characteristics, as the collateral fund must be built up in a conservative manner and Pfandbrief agents are also exposed to a debt-equity gearing level. There is no separation of collateral pools asset classes typical of an issuance of asset classes such as asset classes securities (ABS), CMBS or RMBS. However, certain asset classes do represent a certain issuance of asset classes.
Under the Pfandbrief system, however, all Pfandbrief asset pools are covered by all Pfandbrief issuances. Accordingly, the investment exposure for different Pfandbrief ranges does not differ as the same collateral pools and the same Pfandbrief agencies and member institutions hold collateral for such loans.
Peculiarities of one-sided Pfandbrief issues and possible futures deals It is typical that the issue of a Pfandbrief by a Pfandbrief agent to a member institution on the one side and the issue of Pfandbriefe on the other side are not ordered as a single deal. Whilst the Pfandbrief's own liquidity flow, that of member banking credits and that of the mortgage credit should, in principle, be interest-rate and maturity-fair, those Pfandbrief subscribers do not do so with the aim of providing funding to a particular member state.
By default, the Pfandbrief Brokerage House provides its member institutions with the option of funding already outstanding repayable credits or extending new credits prior to issuing a new Pfandbrief family. UBS's one-sided deal shows, however, that the Pfandbrief system can become an effective funding instrument if secure funding is hard to obtain or off-balance sheets cannot be securitized due to a shortage of liquidity.
Contrary to a collateralised funding operation, the advantage of using the Pfandbrief system is that the collateral right is established by statute if the asset detail is duly recorded in the collateral pools without a need for actual transfers. As a result, the member banks can still serve the collateral pool's asset base.
Surveillance of the collateral pools is also made easier by the registry system and under the Pfandbrief Bank's oversight (and supplementary supervision). The disadvantage, however, is the high LTV requirement for the collateral pools' asset holdings. In the near term, it is anticipated that other member institutions and UBS AG will again attempt to conduct funding operations via the Pfandbrief system in Switzerland.
Opinions have publicly stated that certain financial institutions are committed to closing such deals in the near term and that the total amount of such deals will be up to CHF 4. If all these operations are carried out as previously stated in the Pfandbrief system, the statutory environment for the Pfandbrief agents (in particular the Pfandbrief bank) may need to be adjusted.
Pfandbriefbank would need additional capital in order to meet the indebtedness figures prescribed by the Pfandbrief Act. As this capital requirement can only be transient, capital injections by member banks' junior notes are the most likely options. In addition, Pfandbrief intermediaries would be subject to a higher level of exposure in connection with individual exposures made available to member institutions in such operations.
This means that shareholders would undertake not to implement the Pfandbrief they held unless the member banks in question paid back the loans or the corresponding collateral pools were implemented. Otherwise, the Pfandbrief Agent risks a shortage of cash in circumstances where the Pfandbrief matured and the member in question has not paid back the corresponding credit.
Under such a situation, Pfandbrief redemption would have to be postponed until the collateral pools asset values have been called in.