• Due to scarcity of Finance, Housing remains a
distant dream for many people.
• To boost investment in the housing industry,
the Government established the Housing
Development Finance Corporation in 1977.
• Numerous tax concessions were announced
like currently interest and repayment of
borrowed capital and capital gains rollovers.
• In July, 1998, the government announced the
setting up of National Housing Bank fully
owned by RBI with the objective of providing
Housing finance to all sections of society.
• The NHB also functioned as a regulatory body
for the housing finance industry and issued
regulatory directions and guidelines to the
Housing Finance Companies (HFCs)
• Till the 1990s , it was largely a seller’s market.
• With the entry of commercial banks and
private sector banks, marketing began to play
an important role.
• HFCs marketed their schemes through agents
known as DSAs (Direct Selling Agents)
Disbursing a house loan
• The first step is determining whether or not,
the applicant satisfies the eligibility criteria.
• HFCs consider factors such as an applicant’s
age, income level and stability of income
• Generally three types of appraisal are
conducted by the HFCs
• This is conducted to assess the applicant’s
repayment capacity over the loan tenure.
• The factors considered are:
• Academic Background
• Employment stability
• Family background
• Assets and liabilities
• The documents submitted are verified by a
lawyer to confirm whether the holder will be
able to generate a mortgage in favor of the
HFC or not.
• The applicant’s original documents are
• All other information submitted is also
• Checks to ensure of the quality of the material
of the house.
• Loan amount can be disbursed in entirety or
• Repayments are by way of EMIs
• Disbursement is generally done on the basis of
fixed or floating rate of interest.
• Charged at the time of processing the
• Generally 0.8% to 1% of the loan amount.
• Charged when the loan is sanctioned.
• Generally 1-2% of the loan amount.
Early redemption charges
• For prepayment of the loan.
• Generally 2% of the outstanding balance
• Bank may waive any of these fees for specific
categories of customers.
• The registration papers of the property are
held by the HFC till the loan is fully repaid.
• The primary source of funds for any HFC is the
interest on loans disbursed.
• HFCs make money on the spread between the
cost at which they source their funds and the
rates charged to customers.
• Fannie Mae was a Depression-era creation of the
federal government that had been charged with
establishing a secondary market for home loans.
• By purchasing qualifying residential mortgages
• from home-loan issuers, it provided these
institutions with funds for the continued issuance of
mortgages, thereby promoting the government’s
goal of increased homeownership.
• In November 1931, President Herbert Hoover
outlined a plan for the creation of twelve
regional Federal Home Loan Banks (FHLBs)
with the capacity to lend upwards of $2 billion
to member mortgage institutions.
• Originally chartered as the National Mortgage
Association of Washington in February 1938,
the agency was renamed the Federal National
Mortgage Association (FNMA).
• Over time, the FNMA would come to be
known also as Fannie Mae.
• The FNMA opened its doors with “an initial capital of
$10 million” supplied by the Reconstruction Finance
Corporation, its supervising agency.
• Its role was primarily buying, holding, and selling
“FHA-insured mortgage loans which had been
originated by private lenders,” thereby allowing the
latter to remove the loans from their books and use
the income to finance further mortgages
Federal Housing Administration (FHA).
• The FHA challenged this status quo. For a small
premium (fee), it offered to insure “the repayment
of principal and interest” on any mortgage “held by
any authorized lending institution,”
• but only so long as the mortgage conformed to FHA
• To be eligible for FHA insurance, properties needed
to be examined by a local FHA agent.
• The Federal Home Loan Mortgage
Corporation (FHLMC), or Freddie Mac.
• The Government National Mortgage
Association (GNMA), also known as Ginnie
• Dot Com Burst and Sept 9/11 attacks
• US Govt. adopted a policy of Credit Driven Consumption led
• Interest Rates were slashed to ease liquidity from 2001
• By 2003 the Fed Funds rate (Fed rate) had gone down to as
low as 1%.
• Lower interest rates made Home loans cheaper
• High demand in Housing Markets lead to Real Estate Prices
• Real Estate as an asset class became very attractive.
• Returns generated were very high.
• Banks were Flush with liquidity because of Low Fed
• Prime rate went down to 4.25% in January, 2003
from 9.05% in January 2001.
• However Prime market did not give the banks the
high credit growth they had targeted.
• Started lending to subprime borrowers.
• Bankers assumed real estate rates were set to
• Aggressive Lenders went to the extent of
Financing with more than 100% of the Asset
• Subprime borrowers were offered Mortgage
Loans as ARMs.
• Higher Risks – Higher Premiums.
• Lending operations were carried out by
• Were paid Commission for underwriting
• Were not responsible for recovering those
Loans in case of a default.
• Often underwrote Mortgages even when
there was no proper documentation.
• Banks took the Securitization route to transfer
the Risk off their Balance Sheets.
• Sold the Mortgage Loans to GSEs and
• Funds generated from securitization were
again extended as Mortgage Loans.
BORROWER BANK INVESTOR
SALE OF LOAN BACKED
BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO
SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES.
FUNDING AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR.
SALE OF LOAN TO
• Banks created MBS – A Bond.
• Were entitled to cash flows from the
• Bunched MBS into several Tranches – Pooling
• Many Hedge Funds and Institutions invested
in High Risk – High Return MBS.
FROM MBS TO CDS
• An MBS Investor could buy a CDS issued by other FI’s
by paying a premium.
• In return the FI guaranteed the cash flows from the
• CDS market was unregulated.
• Till 2000 the Number of CDS players was limited.
• Early 2000 saw a number of players including
Investment Banks, insurance companies and
speculators entering the CDS Market.
What is Credit default swap?
Credit default swaps allow one party to "buy"
protection from another party for losses that might
be incurred as a result of default by a specified
reference credit (or credits).
The "buyer" of protection pays a premium for the
protection, and the "seller" of protection agrees to
make a payment to compensate the buyer for losses
incurred upon the occurrence of any one of several
specified "credit events."
RISK TRANSFER MODEL
LOAN TRANSACTION CREDIT DEFAULT SWAP OR
CREDIT LINKED NOTE
BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF
BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS.
Suppose Bank A buys a bond which issued by a Steel
To hedge the default of Steel Company:
Bank A buys a credit default swap from Insurance
Bank A pays a fixed periodic payments to C, in exchange
for default protection.
Credit Default Swap
Bank A Buyer
Insurance Company C
Contingent Payment On
• Estimated size of CDS Market in 2000 was USD 900
• Estimated size of CDS Market in 2007 ballooned to
USD 45 Trillion.
• This was three times the size of the GDP of USA.
• US Proposed Budget for the IRAQ war – USD 60
• Actual expenditure had reached over USD 500
• Heavily borrowed short term funds.
• Had to rely on the Money Market.
• Allan Greenspan – US Federal Reserve Chairman –
increased interest rates.
2003 - 2006
• In 2003 the average short term borrowing
rates on three month Treasury Bill was 1%
when the average 10 year T-Bill rate was 4%.
• In 2006, the average three month Treasury Bill
rate went up to 4.85% whereas the average
10 year T-Bill rate was 4.79%.
• Normally short term rates are less than long
• The cost of funds for lending institutions increased.
• They raised the rates on ARM.
• With increasing interest rates, the housing market
started witnessing a decline in Demand.
• Liquid money started flowing into commodities.
• Led to a surge in commodity prices and therefore
• To control Inflation, Interest rates were increased
• Borrowers started defaulting on their
payments because of increasing interest rates.
• Losses for Investors and institutions dealing in
• Rating agencies downgraded several MBS.
• This made the MBS Market illiquid.
• Investment Banks had to face significant losses.
• Decline in share prices.
• Few of them which had invested heavily started
defaulting on their obligations.
• FI’s which had underwritten CDS faced the pressure
• This led to Bankruptcies of several FI’s involved in the
Trading of MBS and CDS.
• Led to a liquidity crunch and the subprime crisis.
• The Troubled Asset Relief Program (TARP) is a
program of the United States government to
purchase assets and equity from financial institutions
in order to strengthen its financial sector.
• It is the largest component of the government's
measures in 2008 to address the subprime mortgage
• TARP allows the United States Department of the
Treasury to purchase or insure up to $700 billion of
IMPACT ON INDIA
Indicator Period 2007-08 2008-09
Growth, per cent
Real GDP Growth April-December 9.0 6.9
April-February 8.8 2.8
Services April-December 10.5 9.7
Exports April-March 28.4 6.4
Imports April-March 40.2 17.9
GFD/GDP April-March 2.7 6.0
April-March 16,569 12,366
Rs.per US$ April-March 40.24 45.92
National Housing Bank
• NHB was set up in 1988.
• It is the principal housing finance agency in
• The promotional role includes
• promotion of HFIs/HFCs
• Coordination with Government and other
agencies in securing necessary amendments
to the existing laws to remove impediments in
the housing sector
• The regulatory powers exercised earlier by the
RBI relating to HFCs are now the domain of
• It regulates them through directions and
• The financial support by the NHB to HFCs is in
the form of equity capital and refinance
promotion of loan linked savings instruments
and mortgage backed securitization.
NHB Directions cover
• Net owned funds
• Period of deposits
• Ceiling on Deposits
• Information in the reports of the Board of
• Accounts and Auditor Reports etc
Acceptance of Public Deposits
• Any HFC having Net owned funds of less than
Rs 25 lakhs cannot accept public deposits.
• A HFC having NOF of Rs 25 lakhs and above
and having a minimum credit rating of ‘A’
from any of the approved rating agencies as
well as complying with all the prudential
norms, can accept/renew deposits upto five
times its NOF.
• In the absence of credit rating, there is a
ceiling of two times the NOF or Rs 10 crore,
• Compliance with prudential norms
• Capital adequacy ratio of 15 per cent and
Mortgage Backed Securitization
• Packaging of designated pools of Mortgage
loans originated by a primary lending
institution/HFC and the subsequent sale of
these packages to the investors in the form of
securities which are collateralized by the
underlying mortgages and associated Income
• Sale of specific loans to a special purpose
• Which in turn issues securities
• The securities are rated by an independent
• Government has enjoined upon NHB to play a
lead role in starting MBS and development of
a secondary mortgage market in the country.
• It placed the first ever MBS issue successfully
in the Indian Capital Market during August,
• The NHB will purchase from the originator, a
pool of retail housing loans that constitute
• The individual loans repayable in EMIs will
then be packaged and offered to investors by
way of securities in the form of pass through
certificates(PTCs) without recourse to the
• The issue proceeds will then be used by NHB
to pay part consideration for the receivables
purchased to the originator.
• NHB will appoint itself as the sole Trustee and
will hold and administer the receivables as
Trust Property for the benefit of PTC holders.
• The originator will continue to administer the
housing loans as Servicing and Paying Agent
• Established on 25th
• Fully owned Government of India Enterprise
• Principal mandate was to ameliorate the
housing conditions of the Low Income Group
and economically weaker sections.
• To finance or undertake
• Housing and Urban Development
Questions for Revision
• What are the different types of appraisals
carried out by Housing Finance Companies ?
Describe some of the fees charged ?
• Write a short note on
– Mortgage backed Securities
– Subprime Crisis
– National Housing Bank