The thesis examines why the Danish mortgage market is considered as one of the best in the world and how this system could be improved. It is found that the high level of transparency, the match funding principle, a direct link between borrowers and investors, and a range of terms and regulatory requirements are providing cheap financing to homeowners and a secure investment environment. However, the system is limited to financing 80% of the property value, whereas borrowers are allowed to finance 95%. The last 15% is usually financed through bank loans and does not utilize any of the mentioned characteristics that benefit borrowers and investors. Therefore, the Danish mezzanine financing is the focus area of improvement.
The American mortgage market was investigated to find inspiration for the structure of the improvement. By combining the tranche structure of American MBSs with the transparency and direct link between borrowers and investors, seen in the Danish market, a product is created—The Jigsaw—which provides borrowers with cheaper financing and targets a wide investor segment, the missing piece in the Danish mortgage market. The Jigsaw grants mezzanine financing to borrowers, collects the loans in large pools, which are structured in a senior, junior, and equity tranche. Through an exchange, the tranches are each funded by a separate bond that mirrors the liabilities of the borrowers. The cash flows from the loans are distributed to the tranches in a waterfall structure, making the senior tranche the safest investment and the equity tranche the riskiest investment.
The credit risk framework developed by Vasicek in 1987 is used to model the product. The industry standard Gaussian copula is used to estimate the underlying default distribution, and a Student t copula, more fitting to real world conditions, is used to stress test the Gaussian. The creation of the tranches is based on an approach, where the expected loss in the tranche is maximized while maintaining a target credit rating from Moody’s, defined by a maximum expected loss. Both corporate bond and CLO spreads for the relevant ratings are used to price the tranches. CLO spreads negate much of the mispricing done when using corporate bond spreads, as they are based on similar tranched products, consisting of large credit portfolios.
Over the range of probable parameter values and in both models used, the all-in interest rate ranges from 1.81% - 2.36% when using corporate bond spreads, and from 2.88% - 4.16% using CLO spreads. The results are robust over the models used, and general conservative estimates increases the confidence in the base case result of a 3.31% all-in interest rate charged on borrowers. A result very competitive with the current offerings from the consumer banks that range from approximately 5% - 10%. The Jigsaw will be distributed through the retail banks, replacing their current offerings and lowering their capital requirements.
|Educations||MSc in Finance and Investments, (Graduate Programme) Final Thesis|
|Number of pages||134|