(Bausparen)
- Basic Design and Regulations -
IFC & Russian Banking Association Workshop
March 12, 2008
Moscow
HansJoachim Dübel
Finpolconsult .de
, Berlin
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 Types of CSH contracts and risk profile; access to loans; pricing conditions; differences to mortgage banking;
 Liquidity (demand) management of CSH portfolios;
 Interest rate/solvency management of CSH managing institutions;
 Credit risk management of CSH managing institutions;
 Institutional models (Public fund, Housing Bank,
Bausparkasse, Building Society, Universal bank);
 Financial regulations of CSH managing institutions
(special bank act, special product regulations, etc..).
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Function of CSH in the Russian Mortgage
Funding Structure (per eo 2007)
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Some History of Bausparkassen and Building
Societies in Europe and the U.S.
Saving against a loan promise in a collective capital pool is one of the oldest financial institution designs.
Historically, mortgage finance in many countries competed fiercely with public sector and corporate finance - and often had to rely on collective systems.
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Closed System Open System
Rule: Inflows = Outflows
 No capital market funds needed
 Pricing can be fixed
 Loans are small (S ~ L)
Outflows > Inflows possible
 Capital market funds needed to fill gap
 Pricing cannot be fixed
 Loans can be large (S > L)
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Also, semi-open systems exist with fixed real interest rates over saving and loan outstandings adjusted with inflation indices (e.g. Slovenia)
In the end, only closed or semi-open systems bring sufficient additional value as they are able to create fixed-rate loans largely independent from capital markets circumstances.
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 The CSH institution decides about an allottment, if there is enough capital.
 Since new savings are stochastic, waiting phases may arise. They must not be excluded in German law.
 “Good brothers” (savers-only), reserves and strict assetliability management rules help to minimize risk of waiting periods.
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Function of CSH in the Russian Mortgage
Funding Structure (per eo 2007)
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 There are 3 elements of value in a CSH contract for consumers:
 Savings product: but usually below market, except subsidies
 Interest rate option: fixed-rate long-term loan promise in the future, with interest rate being locked in today
 Credit risk option: CSH interest rate does not change during savings phase, but the creditworthiness of the borrower may
– or may be low to start with and savings signal his ability to service a loan.
These values change with market conditions  demand for
CSH contracts changes with market conditions.
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

When is closing a CSH contract of greatest value?


When interest rates are currently low and expected to increase in the future.
When the volatility of interest rates is high
AND VICE VERSA !!
Interest rate options may have considerable value, e.g. in 4-5 years from now 30-50 bp.
The interest rate option ALONE should suffice to encourage a consumer to save below market.
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CSH contract demand in Germany and Capital
Market Rates


In the past 20 years close inverse correlation with interest rates.
Distortions in the high inflation phase
(1980s crisis due to long waiting periods).
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Allocation of Loans must Follow Strict Rules,
Even if Interest Rates Do Not Change !
 Liquidity in the collective is a function of four factors:
 the minimum amount of savings required for loan eligibility,
 the length of the minimum savings period relative to the loan term,
 the loan-to-savings multiplier,
 the number of ‘good brothers’ (savers who do not take loans) relative to the totality of the saver collective.
 Loan demand must be proportional to contribution; key contract steering variables are the individual and collective ‘Saver-Fund Effort Ratio’ – basically the ratio of accumulated savings to the financing demand.
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


Loan-to-savings multiplier of 1-1.2
Initial liquidity surplus, invested in reserves to fill subsequent liquidity gap as loans start to get disbursed
Reaches steady state where
Savings inflows + principal repaymt =
Loans outflows.
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


Loan-to-savings multiplier of 7
(Case: Iran)
Initial liquidity sur-plus, as before, yet cannot fill large sub-sequent liquidity gap
Does not reach
“Steady-State”, I.e.
Savings << Loans
Only solution:
“open” funding model, market interest rates
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German Bausparkassenverordnung
 CSFER must always exceed 1 - by law, for EACH scheme/contract type.
 ISFER must always exceed 0.5, for NEW schemes always exceed 0.7.
 Minimum allottment number (Mindestbewertungszahl) to control
ISFER for different types of contracts.
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 Contract 1: “Stable”
 Savings period = 5 years
 Loan multiplier = 1.2
 Waiting period
 65% loan takers
 Contract 2: “Unstable”
 Savings period = 3.5 years
 Loan multiplier = 7
 Waiting period = none
 25% Loan takers
 High individual and collective Saver-Fund Effort
Ratio, although many loan takers.
 Low individual Saver-Fund
Effort Ratio, low collective ratio even although few loan takers.
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Effort ratios compared: Bausparkasse,
Building Society (open system), Iranian lender
0.80
0.70
0.60
0.50
German Bausparkasse
0.40
0.30
U.K. Building Society
U.S. Savings &
Loan
0.20
0.10
0.00
1369 1370 1371 1372 1373 1374 1375 1376 1377 1378 1379 1380 1381
Years closed
FUNDING open
Bank Maskan
Effort Ratio
..considering waiting period
Individual Saver-Fund
Effort Ratios
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Technical Reserves Must be Held for Liquidity
Management, to Minimize Waiting Period



Germany: ‘bauspartechnischer Sicherungsfonds’, introduced in
1990 (Bauspar crisis in the 1980s, long, volatile waiting periods triggering demand decline)
Specification of reserve fund (up to 3% of CSH deposits) to cover fluctuations in fund flows – reserves increase if savings>loans.
Sponsored by interest revenues on non-allotted amounts
(Schwankungsreserve), from the excess of such revenues over comparable CSH revenues.
Fund use (‘can’, ‘must’) triggered by indicators – effort to stabilize ISFER when liquidity situation changes.
Note: the higher interest rate (contract demand) volatility, the higher must be technical reserves
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CSH Loans in Germany usually ‘Senior-Sub’
= 100 % of the purchase price
20% Downpayment
10-20% Bauspar funds
(SUBORDINATED)
60-70% Mortgage (SENIOR)
Legally possible in Russia ! (not CZ)
Reason: Bauspar loans are small, compared e.g. to new construction costs
In Austria, Bauspar frequently first rank.
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


Typical regulations:
 LTV of loan part (contract value = loan + accumulated savings) not exceeding
80%, i.e. CSH funding goes from, say 70% - 90%.
 Share of non-collateralized lending is usually limited by law (e.g. Loans <
E20K).
 CSH institution has the right to refuse borrowers.
Risk-mitigating factors



Loan is below market rate.
Interest rates are fixed over whole lifetime of contract, also no Basel II pricing.
Consumer has signalled affordability through pre-savings.
Risk-increasing factors


Rudimentary underwriting process.
CSH frequently subordinated – senior-sub structure.
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

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Case: senior-sub lending
Bank (and Bausparkasse) capital requirements tend to create gap between economic and regulatory costs of capital.
Bausparkasse prices at the margin (i.e. 6% for 70-80% LTV), banks on average (i.e. 5.5% for 0-
80% LTV, but 5% for 0-70% LTV)
– which option is cheaper?
Competition with mortgage insurance, agency lending creates regulatory, policy finetuning problem.
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
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Special bank: Germany, Austria, Czech Republic, Hungary. Idea is to fully separate collective fund and liquidity risk management.
Universal bank: France, Maghreb countries. Open systems = low liquidity risk. Usually licensing.
Special funds: Latin America and Asia, frequently as monopolistic public provident funds collecting wage taxes (often lottery effects).
Housing banks (special regulation): Iran.
Unregulated:

 joint venture between the German Bausparkasse Schwaebisch Hall, a special bank in Germany, and Construction and Credit Bank of China, in Tienjin/China. China practices mandatory CSH in public funds in parallel.
Also, the Indian scheme set up by Birla homes so far is unregulated. Both schemes are very conservative and managed by experienced German lenders.
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Option Character Advantage Disadvantage
Universal bank Open funding
Universal bank license
Building society
Specialized
CSH institution
Open funding
Special bank license
Closed funding
Special bank license
All housing loan products
Flexible funding options
(subsidy independent)
No minimum scale requirement
No additional regulatory/ supervisory costs
Efficient originator
All housing loan products
Special product focus
Special target group focus
Flexible funding options
(subsidy independent)
Efficient servicer and originator
Applicable in high inflation context
Special savings mobilization focus
Special housing lending focus
No special product focus
No special target group focus
Inefficient servicer
Speciality requires minimum scale
Special regulatory/ supervisory costs
Small loan sizes only
Inflexible funding
(subsidy dependent)
Speciality requires minimum scale
High special regulatory/ supervisory costs
Inefficient originator and servicer
Applicable situation
Small market
Low inflation
Mid-sized market
Low inflation
Large market
All inflation scenarios
Generally, open systems more suitable for universal banks (France).
Closed systems are run by universal banks (Slovenia).
Closed systems need firewalls, licensing due to high risks.
Fund mixing not an option for closed systems.
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


1998: market rates dropped below Bauspar rates
 prepayments.
Product converted from fixedrate to floating-rate with caps
(i.e. semi-open system)
Balance sheet opened to allow
Bausparkassen to offer mortgage loans, issue bonds/MBS.
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CSH Manager Balance Sheet
Assets Liabilities Presupposes segregability of assets from bank balance sheet
(super-seniority).
CSH Loans
Bridge Loans
CSH Liquid Investments
CSH
FUND
CSH Deposits
CSH Technical Reserves
CSH Profit Account
Comparable to covered bonds/Pfandbriefe
(special insolvency privilege).
Other Liquid Investments
Other Investments
Other Lending
Fixed Assets
OTHER
ASSETS
Alternative is US trust.
Deposits
Bonds
Other Reserves
Capital
Fund supervised by trustee or auditor.
Bridge loan = advance/interim loan.
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CSH Manager Cash Flows
Cash Inflow Cash Outflow
CSH New Deposits
CSH Loan Amortization
Bridge Loan Amortization
CSH Deposit Interest
Liquid Investment Principal
Liquid Investment Interest
CSH Loan Interest
Bridge Loan Interest
CSH Fee Revenues
Investment Management Fee
Non-CSH Cash Inflow
CSH
FUND
CSH
MANAGER
CSH Deposit Withdrawals
CSH Loan Disbursements
CSH Technical Reserves (net)
New Liquid Investments
Investment Management Fee
CSH Profit Share
CSH Deposit Interest
Credit Risk Provisions
Distribution Costs
Servicing Costs
Non-CSH Cash Outflow
To avoid excess profits as in CZ/SLK:
CSH fund pays manager an investment fee and a profit share.
In exchange receives an interest in non-CSH investments.
Under special bank, profits are entirely internalized with the fund manager.
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Czech Republic:
Bausparkassen mainly give interim/advance loans at market rates.
Options: special reserve funds, profit allocation rules.
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 General Regulations
 Core and admissible range of operations
 General contract conditions and consumer information
 Relation between CSH Fund and Fund Manager
 Special purpose character of the CSH Fund
 Firewalls between CSH and other operations of the manager
 CSH depositors are secured and enjoy bankruptcy preference
 Investment in CSH loans
 Investment in interim/advance loans and other loans
 Other investment rules
 Profit allocation rules
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 Risk Management Regulations
 Suitability of the Fund manager
 Collateralization and other sureties
 Underwriting standards
 Valuation standards
 Individual Saver-Fund Effort Ratio (ISFER)
 Collective Saver-Fund Effort Ratio (CSFER)
 Protection of the real value of CSH deposits
 Mandatory technical reserve fund for CSH specific liquidity risks
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 Supervision
 Rights of supervisors
 Trusteeship and relation to supervision
 Reporting and auditing standards
 Approval of new tariffs or product-lines
 Approval of loan transfer
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

Standard special bank law
Problematic issues:

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Collateralization requirement for loans: Russia ‘can’, German ‘must’.
Lower Bauspar-technical reserves - 1.5% vs. 3% in Germany, Russia ideally
~5%. Note: initial excess profits should be reserved.
Investment in Russian (corporate) covered bonds?
80% interim/advance loan limit too high (CZ/SLK experience)


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German law: max 75% (used to be 8*capital), short-term loans (<=4 years)
If special bank is created, profit allocation rules should be improved. E.g.
German insurance: 90% of excess profit to be allocated to the collective.
Special (group) deposit insurance system? No private whistleblower function at the moment.
No risk management ordinance (Bausparkassenverordnung).
No finetuning of regulatory issues – re mortgage insurance, covered bonds.

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 With fixed spreads (Russia proposed 3%), CSH institutions make their profits to a large degree on fees.
 Fees are anticipated to the savings phase to avoid their inclusion into the loan effective interest rate (annual percentage rate of charge, APRC).
 Loan effective interest rates are distorted since they do not account for savings below market rates.
 APRC concept should require full discounting of all savings and loan payments, i.e. Include both savings and loan phase.
 Counterargument of insecurity about a possible waiting period is irrelevant in practice.
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END
Hans-Joachim (Achim) Dübel
Finpolconsult .de
aduebel@finpolconsult.de
www.finpolconsult.de
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