Internationalization of Capital Market

Summary

Unlike United States and Europe, Hong Kong wasn’t a mature market ready for mortgage-backed securities during the early 1990s.  After experiencing the failure of issuing MBS in Hong Kong by Chase Manhattan in 1988, Hong Kong Government founded the Hong Kong Mortgage Corporation Limited to lead the development of local debt market.  The major function of HKMC was to purchase mortgage loans and issue the loans as debt securities.

John Lee, a retail banker in Hong Kong, believed that his bank would miss the opportunity of earning significant potential profits from MBS if the old assessment and strategy of asset-backed securities were kept.  The bank needed to response to the public demand for MBS to become more competitive.  At the moment, John had to provide a comprehensive review of Hong Kong MBS market and HKMC to help his bank determine whether or not participating in the HKMC programme, or if there would be better alternatives to choose.

Internationalization of Capital Market

Internationalization of capital market refers to the raising tendency of international trading that issuers, brokers, dealers, investors and marketplaces search for potential transactions cross the boarders.  This trending could benefit all players involving the participated countries if the process is managed efficiently.  But at the same time, there are certain emerging market issues that need to be faced and solved when manage and execute the transactions.

• U.S Model V.S. Hong Kong Model

As mentioned in the case, any income-producing asset with an adequate performance record could be securitized, and residential mortgage loans was the core sector of the global asset-backed securities (ABS) market.  In the 1930s, the Federal National Mortgage Association (Fannie Mae) was the first organization that purchased mortgages from commercial banks and issued debt-based securities in the United States.  It introduced “pass through” system that all receivables (loan principle repayment and interests) on the mortgages passed through to the security holders, instead of being paid to the banks.  After Fannie Mae established the system, property had become the most common asset used in ABS deals.  At the end of 1994, three key mortgage corporations (Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Government National Mortgage Association) in the United States held and guaranteed $1.785 billion unsecured debt securities and MBS.

Compared with U.S., Hong Kong didn’t have a mature MBS market in the 1990s.  It was first introduced in 1988 by Chase Manhattan, many banks and credit card companies joined the securitizing mortgages market.  However, fewer investors were interested in MBS due to the lack of conformity of the underlying pool of mortgages and the quality issues.  The MBS market structure established in Hong Kong was similar as what U.S. had.  The Special Purpose Vehicle (SPV) was the channel between commercial banks and security investors, same as Fannie Mae.  In this case, the Hong Kong Mortgage Corporation Limited (HKMC), which was founded by the Hong Kong Government, acted as SPV.  HKMC purchased residential mortgage loans from banks and packaged the loans into MBS with a guarantee on the payment of principal and interest.

• Emerging Markets Issues

Even though ABS was well developed in the United States and Europe in the 1990s, there were still certain limitations and barriers blocked it from the Asian market.  Unlike U.S or Europe, fewer security investors were there in the Asian market, which couldn’t provide enough liquidity for MBS and commercial banks.  Meanwhile, the lack of investor confidence and regulatory, and tax issue also dragged the development.  Not surprisingly, Hong Kong also faced the same principle problems, that the first individua institution to securitize mortgages had failed  

Adaptation of Mortgage Security Structure

• Hong Kong Government

To develop the debt market and secondary mortgage market in Hong Kong, the local government initially funded HK$3 billion to HKMC in the late 1990s.  Hong Kong Government expected that HMCK could also help promote home ownership and improve banking and monetary stability.  There were several advantages to have a better MBS market.  By having mature MBS, Hong Kong could achieve more potential secondary market for additional investment and would face less risk compared with other market.  Because of the internationalization of capital market, a government supported MBS would attracted more foreign banks and investors to participate in the Hong Kong market to increase the security liquidity.  From the participating banks’ perspective, MBS system could reduce their credit ratios and keep their liabilities off the books.  

In this case, Hong Kong Government intermediated between investors and banks through HKMC.  There were two more options out there for the MBS investors.  One was getting securities directly from banks, the other option was buying from securities companies, who packaged mortgage to sale and played as intermediator as well.  Unlike the alternatives, the government system had extra guarantee for the investors, and provided faster issuance.  As a return, there would be additional fees passed on to investors.

• Commercial Banks

Since mortgages had high credit ratings, many banks preferred not selling their mortgages to the HKMC at the beginning.  However, HKMC’s mortgage securitization programme provided a win-win plan that could satisfy both servicing banks and HKMC’s goal of benefits.  The servicing banks were entitled to purchase the MBS back by mortgages, the banks cashflow won’t change a lot.  At the same time, the servicing banks had to pay the HKMC a fee for increasing credit and mortgage securitization.  The MBS were guaranteed by the HKMC and 50% risk weighting loans were converted into 20%, therefore the credit risk exposure and investment risk were minimized.  Also, HKMC’s issued MBS was qualified as liquefiable assets under the Banking Ordinance, it provided helpful balance sheet management tool for servicing banks. The banks could maintain the cashflow on mortgages for a long time as they held the Notes, and maintain relationships with customers for cross-selling opportunities.  Most importantly, banks participated the HKMC’s MBS programme could issue securities much quicker and less costly compared with issuing MBS on their own., By having its own mortgage loan standards and structure, the HKMC made sure that all mortgage and MBS through its programme were under controlled, and able to promote the capital market.