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The Asian Mortgage Conundrum: What Will the Catalyst(s) Be for a True Housing Finance Boom?

Unlike their Western counterparts, the major Asian economies have thus far resisted the complete metamorphosis of their mortgage markets into the classic Anglo-American model. The American system, as highlighted in a recent media blitz, is replete with intermediaries (“brokers” as we know them), non-bank entities (mortgage banks like Countrywide, Indymac,…

Unlike their Western counterparts, the major Asian economies have thus far resisted the complete metamorphosis of their mortgage markets into the classic Anglo-American model.  The American system, as highlighted in a recent media blitz, is replete with intermediaries (“brokers” as we know them), non-bank entities (mortgage banks like Countrywide, Indymac, and GMAC), and a vast – albeit rapidly shrinking – secondary market where the loans are bought and pooled together into structures known as mortgage-backed securities before being sold to institutional investors.  The U.S. and U.K. also feature fairly high ratios of mortgage debt outstanding to gross domestic product (MDO/GDP), which is used by many industry pundits to gauge the development of a country’s mortgage space.

While these features and numbers are respectable, they are more expected than surprising given Western countries’ large economies and overall advanced states of development.  Many countries have achieved record MDO/GDP levels over the past several years during a global mortgage expansion, a great deal of which has come from home price appreciation (HPA).  Of the fifteen largest world economies, eleven experienced over five percent year-over-year increases in HPA between 2000 and 2005.1 2

However, when looking at the preeminent Asian economies (for the purposes of this analysis we use the sampling of Japan, China, and South Korea), they have neither the MDO/GDP ratios nor the exorbitant market features (i.e. brokers, mortgage banks, secondary markets) that many Western economies feature, even though Asian economic growth (measured in terms of GDP) has met or exceeded that of Western countries over the last several years.  One may examine two distinct factors to account for the current state of development: government controls and lack of secondary market development.

Government Controls: Big Brother or Responsible Parent?

Government interference has manifested several different forms in the past several years in Asian economies.  China is the most glaring example: already a concentrated, bank-driven market (the “Big Four” state-owned banks control a commanding 75% market share),3 the People’s Bank of China (PBOC) not only sets inter-bank borrowing rates but also dictates the mortgage interest rates to be charged at state-owned banks, regardless of borrower credit history or a bank’s internal cost structure.  Furthermore, the PBOC sets the deposit rates that banks use to fund the mortgages that they originate, cementing the gross mortgage spread (and thus profitability) of the banks’ mortgage operations.  Incidentally, the PBOC has raised interest rates four times since September 2003 in an effort to “keep the property market from overheating.”4 Few foreign lenders have entered Chinese territory due to the regulatory uncertainties and intense competition, choosing instead to purchase equity in Chinese financial institutions (The Dutch conglomerate ING has a 19.9% share in the Bank of Beijing).

The government is attempting to contain growth in an effort to preserve affordability, especially given the growing wealth disparity between urban and rural Chinese.  However, mortgage volume has experienced over a 40% compound annual growth rate since 2000 and it appears that Chinese householders are increasingly looking to modern mortgage solutions to finance home purchase.  The market is craving innovation and cannot truly develop unless competitive pricing is allowed, yielding better consumer choice.

The Japanese and South Korean governments have similar features in their housing regulations but more sensible, market-driven restrictions.  In Japan, private banks have been allowed to set their own rates for years, but the Government Loan Housing Corporation (GHLC) offered subsidized loans at pre-set rates and retained a 27% market share as of 2005.5 However, as of March 2007, the government will cease their direct lending business in favor of the “Flat 35” program where loans are offered through private banks who set rates themselves.  The government is merely seeking to provide stabilization to the market6 while not directly interfering with the competitive balance.

Similarly, in South Korea the government has taken great pains to keep HPA down, specifically by imposing rent ceilings in Seoul, undertaking massive subsidized building campaigns, implementing stiff restriction on loan-to-value ratios,7 and imposing heavy taxes on loans for investment properties.8 Banks were actually forbidden from originating loans in excess of 10 years before 1997, and they are still hampered by numerous restrictions.  However, the government does have valid concerns: Seoul has experienced massive migration in the last several years and prices are almost double that of the other six major metropolitan areas.  Although the restrictive measures on banks may hurt the overall MDO/GDP ratio, they encourage taking advantage of the country’s massive rental housing stock and thus may be a near-term solution to the “rural flight” seen across so many emerging markets.

Mortgages for Sale: Securitization in Asia

The second side to the Asian mortgage conundrum involves the back-end operations of the secondary market.  In the U.S. and many other Western countries, mortgages are channeled through “conduits” who package the loans together and sell them as securitized pools.  Many U.S. companies rely on this secondary market for funding, often taking a loss on the actual loan only to be recompensed later in a gain-on-sale transaction.  Asian banks and finance companies, however, rely primarily on deposits for funding – using their balance sheet to finance the loans and then holding them for the subsequent servicing fees and interest payments.

The development of a secondary market has lagged in Asia for years as consumers showed a general cultural aversion to debt.  Homes were often paid for in full or with extremely high down payments after years of saving while living with family.  The international conduits (e.g. Merrill Lynch, Deutsche Bank, Lehman Brothers) saw little opportunity in the markets and stayed away.  Recently, however, the aforementioned surging property prices and subsequent mortgage demand have prompted calls for more funding.  Banks are also beginning to see securitization as a vehicle for reducing the risk of default as it is transitioned to the investors who buy the loans.  China issued its first residential mortgage-backed security (RMBS) in 2005 (it was worth approximately $US 400 million), while Japan and South Korea issued $US 31.8 billion and $US 3.3 billion worth of RMBS in 2006, respectively (although well over 80% of mortgage funding in both countries comes from deposits).  For comparison, the U.S. issued $US 992.3 billion worth of RMBS in 2006, and this funding covered about half of all U.S. mortgages.  Without this securitization framework, non-deposit taking “mortgage banks” are much less likely to develop and many of the top international mortgage players will refrain from expanding into Asian markets (GMAC-RFC has made a habit out of playing in niche elements of foreign markets but has remained almost exclusively in Europe), thus further hindering the competitive options for consumers.

A Competitive Future?

China’s little brother Taiwan may provide the key to development in the region.  Despite its infant secondary market, the island enjoys a relatively high MDO/GDP ratio and a surging mortgage market.  The reason, quite simply, is its highly fragmented and competitive set of lenders: banks dominate, but the top five lenders only have about 30% of the market and insurance companies (15%) and mortgage banks (5%) also have significant share.  Currently, banks are looking to the secondary market to diversify risk in the wake of the credit- and cash-card crisis.9 Intense competition has forced banks to think outside the box, offer new products, and look to diversify risk among secondary market investors in an effort to increase margins and profitability.  Taiwan offers a glimpse of one potential future, if other countries are brave enough to look.


The development of a secondary mortgage market in the preeminent Asia economies discussed in this article is still in its nascent stage. However, recent rising property prices and subsequent mortgage demand may provide the impetus for these Asian economies to look to the secondary mortgage market for more funding and diversification of risk. The structure used by Taiwan may serve as a model that China, Japan and South Korea can emulate.

Source: www.asiaecon.org |



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