Loan markets in motion - De Nederlandsche Bank
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Loan markets in motion Larger role of pension funds and insurers boosts financial stability
Contents
2 Summary 5
1 Introduction 9
2 Mortgage lending market 11
2.1 An analysis of shifts 11
2.2 Causes 20
2.3 Outlook 23
3 Corporate lending market 27
3.1 An analysis of shifts 27
3.2 Obstacles 31
3.3 Outlook 32
4 Evaluation and recommendations 35
4.1 More stability and diversity 35
4.2 Prudential risks 36
4.3 Recommendations for sector and policy 38
References 39
November 2016Loan markets in motion Figures 1 Overview of shifts in the mortgage lending market 11 2 Mortgage portfolios of insurers and pension funds are growing rapidly 12 3 More mortgages with mortgage funds and banks that are part of insurance groups 14 4 Historic breakdown of mortgage debt outstanding 16 5 Institutional investors are concentrating on mortgages with long fixed interest rate periods 16 6 NHG mortgage loans figure relatively large in the portfolios of institutional investors 17 7 Gross interest margin on new bank mortgage loans 19 8 Solvency capital requirement of non-securitised mortgages of banks, insurers and pension funds. 21 9 Growth of mortgage investments by institutional investors vs growth of mortgage debt 24 10 Overview of shifts in corporate finance 28 11 Market for Dutch private placements is on the rise 29 12 Dutch institutional investors only originate a modest number of corporate loans 31 13 Increasing stake of institutional investors in funds of Dutch private equity and venture capital firms33 Boxes 1 Institutional investors on the mortgage market in a historical perspective 15 2 Gross margins on new mortgage loans at banks 18 3 Capital requirement for mortgage financing by sector 22 4 Simulation of growth of mortgage debt and mortgage investments made by institutional investors 25 5 Lending to the real estate sector 30
Loan markets in motion
Summary
Non-bank lending to consumers and enterprises is There are various reasons for the rise of pension 5
on the rise. Pension funds and insurers are gaining funds and insurers on the mortgage lending market.
ground in the Dutch mortgage market. Since 2010, The low interest rate environment has created
they have doubled their investments in mortgage addtional incentives for pension funds and insurers
loans and currently finance 20% of new mortgage to look for investments with attractive yields,
production. If we also include bank subsidiaries limited risks and relatively low capital requirements.
of insurance groups, this rises to more than one The growing confidence that investors have in
quarter (28%). There is also growing interest from the Dutch mortgage market, partly owing to
foreign market players, while bank mortgage loan the modest losses on mortgage loans during the
portfolios and market shares are falling. There are recent crisis years, also plays a role here. Changing
substantial differences between mortgage loans regulatory frameworks are also responsible for the
funded by banks and those funded by institutional observed shifts. The capital requirements for banks
investors. Insurers and pension funds invest in have been tightened over the past few years, and
mortgage loans covered by the Dutch National the Basel Committee is currently working on new
Mortgage Guarantee scheme more than banks do proposals that may further lift the banks’ capital
and focus on the long fixed interest period market requirements. And finally, the entry barriers to the
segment, with especially large market shares in the Dutch mortgage market have been lowered in the
20-year segment. past few years as mortgage loans have developed
into standard products, due to the lowering of the
The Dutch corporate loan market is also seeing LTV limit, the tightening of income requirements,
changes, although these are limited to large and tax incentives for repayments on new
companies. The latter increasingly seek to fund mortgages.
themselves by issuing corporate bonds or private
placements. Since 2010, the size of the corporate The growing role of Dutch institutional investors in
bond market has grown by 58% (EUR 52 billion), the mortgage lending market is in sharp contrast
while the stock of coroprate loans issued by banks with their modest role in issuing corporate
has fallen. The private placement market has also loans, particularly to small and medium-sized
grown, and Dutch insurers are increasingly active companies. The SME lending market has a larger
in this market. These alternatives for bank lending degree of information asymmetry, and in the
are, however, only accessible to some medium- absence of standardisation of reporting and loans
sized and large companies. SMEs continue to be documentation, monitoring costs are high for
strongly dependent on bank lending. Although new institutional investors.
alternatives like crowdfunding are growing rapidly,
they are still very small.6 The rise of non-bank players on the mortgage foreign players in the mortgage lending market also
and corporate lending market is beneficial to the boosts competition and diversification.
financial system in several ways.
DNB is closely monitoring the lending market shifts
First of all, the growing role that these players and intensifying its supervision where necessary.
are assuming dampens maturity transformation
in the financial system, thereby lowering risk in First of all DNB is watching risk management and
the financial system. Pension funds and insurers continues to monitor institutions’ risk profiles
invest premium and contribution income for the closely. A shift in lending may potentially lead to
long term. Contrary to banks, they do not depend accumulation of credit risk with parties who are
on short-term wholesale funding or deposits that not equipped to manage or fully understand the
may be withdrawn at any time. Reduced maturity risks that they are exposed to. Lending demands
transformation makes the financial system less knowledge of and experience with credit risk
vulnerable to market volatility and lowers the selection and resolution of bad loans. If lending
likelihood of a financial crisis. Pension funds and is done by third parties, e.g. in investments via
insurers thereby primarily concentrate on the long investment funds, the standard of these services
fixed interest period market segment which fits well must be critically evaluated, as these parties do not
with the interest sensitivity of their liabilities. bear the risks themselves. Lending also imposes
requirements on balance sheet risk management.
Secondly, the procyclical character of lending may Mortgage loans are usually less liquid than
ease with the growing role played by insurers government bonds and prepayments may have a
and pension funds. The funding options of Dutch detrimental effect on returns.
institutional investors are limited by the size of their
pension and insurance premium assets. This curbs Secondly, banks must take account of the potential
the risk of these investors facilitating a destabilising impact of lending market shifts on their business
increase in lending. Bank balance sheets on the models. The margins on new mortgage loans are
other hand are elastic, owing to the money-creating under pressure, partly as a result of increasing
abilities of banks and access to wholesale funding. competition. Margins on new mortgage loans in the
long fixed interest period segment, where pension
Thirdly, the larger role played by non-banking players funds and insurers have large market shares, have
may bolster diversity and competition in the lending been shrinking since 2014. Margins at banks started
markets. Not only does this boost the stability shrinking in 2014 and 2015, precisely when many
of lending operations, but it may also increase pension funds started building up their mortgage
efficiency and reduce costs. The increasing role of loan portfolios.Loan markets in motion
Thirdly, long-term customer interests must be the expected growth in mortgage debt. In the longer 7
safeguarded: when renewing their fixed interest term, however, the proportion of bank and foreign
periods customers must not bear the brunt of lending of the total outstanding mortgage debt can
erratic investors with short-term objectives. When increase again. The allocation of domestic institutional
issuing authorisations, the AFM includes rules to investors will at a certain point reach a level where
remind mortgage loan providers of their duty of care any further increase is no longer attractive from
and to address the risk of higher interest rates when a risk-spreading perspective. There is also limited
the fixed interest period ends. pension asset growth due to the increasing number
of pensioners. Banks will also continue to play an
And finally, DNB is monitoring the impact of the important role in the corporate lending market, as
growing market shares of non-bank players on the specific alternative funding sources are still primarily
effectiveness of macroprudential policies. Problems niche markets, or only accessible to large companies.
in the Dutch mortgage lending market also impact
the broader financial sector as insurers and pension Based on the assessed impact of these developments,
funds are playing an increasingly important role DNB has the following recommendations for the
in this market. Amid a growing role for foreign sector and supervisory authorities.
lending, it is important to monitor to what extent ▪▪ Institutional investors must have sufficient
this lending may dry up in times of crisis, as this may expertise to be able to assess the credit risk
have destabilising macroeconomic effects. selection and management of third parties.
▪▪ Bank business models must take account of
Looking further ahead, banks are expected to increasing competition, which may reduce market
continue playing a dominant role in the lending shares or depress margins.
markets, both for mortgage and corporate loans. ▪▪ DNB plans to ask different sectors for information
Pension funds in particular seem to have scope for on the characteristics of mortgage lending
expanding their investments in the mortgage market portfolios on a regular basis.
sharply from the current level: mortgage loans ▪▪ Where necessary we will prompt institutions to
currently account for only 2% of their investment underpin their risk selection or risk management
portfolios. But even if institutional investors continue if their investment portfolios have a large or
to expand their mortgage loan portfolios, banks growing proportion of loans.
are still expected to retain a dominant position. ▪▪ It is important for the AFM to continue
The expansion of mortgage loan investments by monitoring the time horizons of new entrants
institutional investors is curbed by the size of their to the mortgage lending market.
assets and the required asset diversification. In the ▪▪ DNB will continue to monitor whether and how
short term, a possible increase in mortgage debt market shift are impacting the effectiveness of
investments by pension funds may keep pace with its macroprudential instruments.Loan markets in motion
1 Introduction
Non-bank providers are playing an increasing role initiatives are paving the way for non-bank players. 9
in lending to consumers and businesses in the With the Capital Markets Union, the European
Netherlands. Insurers and pension funds have been Commission aims to facilitate non-bank financing
gaining substantial ground in mortgage lending and thus boost diversification of funding sources.
market in recent years; especially pension funds In the Netherlands, too, several initiatives have been
have scope for expanding these activities further launched to address bottlenecks in SME financing,
in the years ahead.¹ At the same time, the market including the birth in 2014 of the Netherlands
share of banks is declining in a number of sub Investment Institution (NLII) and current proposals
markets of the Dutch corporate lending market. for a national investment bank.
For larger companies, the public bond market has
become a more important funding channel; the A shift towards non-bank lending bolsters funding
private placement market, where Dutch insurers of the large Dutch mortgage debt, but is not a
are expanding their activities, is becoming more universal remedy for the long household balance
important for large and medium-sized companies. sheets in the Netherlands. Tax incentives and other
policy measures of the past decades have led to
The rise of non-bank lending is worth highlighting soaring pension savings and home equity on the one
as the Dutch economy traditionally depends hand and mortgage debt of Dutch households on
strongly on bank financing. Dutch banks are still the other. These long balance sheets make Dutch
dominating the mortgage and corporate lending households vulnerable to fluctuations in interest
markets. Some 75% of the total outstanding rates and asset prices. Long balance sheets also
mortgage debt has been extended by Dutch banks. make banks indirectly vulnerable to refinancing risks
For Dutch businesses, too, bank lending is the as they finance a major proportion of their lending
main source of external funding. It is estimated to Dutch consumers and business with wholesale
to account for about 80% of funding to small and funding, which may be less easily available in times
medium-sized businesses.² of crisis. The increased role of pension funds and
insurers on the mortgage lending market means
Various public initiatives are earmarking the there are more long-term savings available for
growing role of non-bank players and the increasing funding of mortgage debt in the Netherlands.
diversity on the lending markets. Several recent Although this makes the financial system less
1 For the purposes of this document, the term ‘mortgage lending market’ refers to the Dutch home
loans market.
2 For the purposes of this report, the term SME is taken to mean small and medium-sized
businesses with up to 250 staff. This is in line with the European definition.10 vulnerable to shocks, it does not in itself change
anything about the long balance sheets of Dutch
households.
About this report This report discusses the
recent shifts in the mortgage and corporate
lending market³ (Sections 2 and 3) and assesses
the impact that these have on the risk profile of
financial institutions and the financial system
as a whole (Section 4). Finally, we present our
recommendations for the sector and supervisory
authorities.
3 In addition to corporate loans, the term corporate lending also covers forms of corporate finance,
such as corporate bonds, private loans and new alternative forms of financing.Loan markets in motion
2 Mortgage lending market
2.1 An analysis of shifts small role in the mortgage lending market, meaning 11
that their share of the outstanding debt remained
Up until recently, the Dutch mortgage lending limited to 8%.
market was almost fully in the hands of banks.
In 2010 the bulk (80%) of outstanding mortgage Non-bank lending of the mortgage lending
debt had been provided by Dutch banks market has been on the rise these past few years.
(see Figure 1 left).⁴ Insurers and pension funds in the Insurers and pension funds are currently funding
nineties and between 2000 and 2009 played a very one fifth (20%) of new mortgage production
Figure 1 Overview of shifts in the mortgage lending market
Percentage
2010 Outstanding debt 2016 Outstanding debt 2016 New loans
(Total: EUR 647 billion) (Total: EUR 662 billion) (Total: EUR 33 billion)
9% 6% 10%
2% 3%
6%
8% 11%
3%
5%
9%
62%
8%
80% 75%
Banks Pension funds
Bank subsidiaries of insurance groups Other domestic players and foreign players
Insurers Source: DNB.
4 Figure 1 shows the sectoral breakdown of outstanding mortgage debt in the second quarter of 2010 (left)
and the second quarter of 2016 (middle), and for mortgage production in the first two quarters of 2016
(right). This is not about the origination of the loan, but about the funding of mortgage loans:
a mortgage loan provided by an insurance group, but stated on the balance of a pension fund, falls within
the category of pension funds. Data on mortgage production are based on a loan level survey among
financial institutions, whereby the share of other domestic parties and non-domestic parties was estimated.
Securitisations are assigned to the issuing institution. For new loans, the share of other domestic parties
and non-domestic parties was estimated.12 (see Figure 1 right). If we also count bank Although the latter fell, they were at a very low level
subsidiaries of insurance groups, this rises to over in 2010, too. Foreign players have also increased
one quarter (28%). As a result, outstanding non- their market shares recently. On the other hand, the
securitised mortgage loans of insurers and pension mortgage loan portfolio of Dutch banks (excluding
funds have doubled since 2010 to EUR 73 billion banks subsidiaries of insurance groups) has declined,
from EUR 35 billion (see Figure 2). The increasing both in an absolute and in a relative sense. They
investments made by pension funds and insurers nevertheless still have the lion’s share of Dutch
in mortgage loans have hardly been at the expense mortgage debt on their balance sheets.
of investments in Dutch mortgage securitisations.
Figure 2 Mortgage loan portfolios of insurers and pension funds broken
down into non-securitised and loans and securitisations⁵
EUR billion
120 18%
100 15%
80 12%
60 9%
40 6%
20 3%
0 0%
2010 2011 2012 2013 2014 2015 2016
Share in total mortgage debt (right-hand axis)
Insurers
Pension funds Source: DNB
5 Figure 2 shows non-securitised mortgage loans held by insurers and pension funds. Dutch mortgage
securitisations held by insurers and pension funds amounted to EUR 4 billion in 2010, and have in recent
years fallen to EUR 2.5 billion to 2016.Loan markets in motion
Banks also continue to dominate new mortgage Before, pension funds originated mortgage loans 13
loan production, accounting for a 62% market share. themselves, whereas they now mostly invest in
loans issued by third parties. This is mostly done by
The degree to which insurers and pension funds means of taking holdings in the mortgage funds
invest in mortgage loans varies strongly. Life referred to above and through originators working
insurers have the largest proportion of mortgage with mandates. In the latter case, pension funds give
loans in their investment portfolios (16%), followed an external party a mandate to provide a portfolio
by non-life insurers (4%) and pension funds (2%).⁶ of mortgage loans with specific characteristics,
The six large insurers in the Netherlands invest most such as a certain fixed interest period. Some
in mortgage loans, albeit to sharply varying degrees. banks and insurers outside the Netherlands are
Pension funds show a different picture: while the also increasingly using such mortgage investment
largest five invest relatively little in mortgage loans, funds and investment mandates to invest in Dutch
the other large and medium sized funds have mortgage loans. Insurers have recently also taken
relatively high investments in mortgage loans. over several existing bank mortgage loan portfolios.
The share of insurance groups in mortgage loan Noteworthy from an international perspective
investments has also increased off the balance is that Dutch life insurers and pension funds are
sheets of the insurance entities. First, there has currently primarily investing in non-securitised
been a sharp increase in mortgage lending by mortgages. Only a few countries have a capital-
bank subsidiaries of insurance groups.In addition, funded pension system in place with sizeable
mortgage funds⁷, that are often part of insurance long-term savings through pension funds or life
groups, are also growing rapidly (see Figure 3). insurers: institutional investors often play an
important role in the mortgage lending market
The role played by institutional investors in the in those countries, but they mainly invest in
mortgage lending market is not new, but their covered bonds or in (government-guaranteed)
approach has changed. In the fifties and sixties, securitisations. The Netherlands is unique in the
institutional investors together with mortgage swift rise of non-securitised mortgage investments
banks were the main providers of mortgage loans, by institutional investors. Among insurers in other
although total mortgage debt was much smaller EU countries, non-securitised mortgages in 2014
at that time than it is now (see Box 1 and Figure 4). accounted for more than 2% of investments for own
6 2016 Q2 figures. The percentage stated for insurers refers to the proportion of mortgage loans in
the total investments for the risk of the institutions.
7 These mortgage funds are classified as investment institutions.14 Figure 3 More mortgages with mortgage funds and banks that are
part of insurance groups⁸
EUR billions
120 18%
100 15%
80 12%
60 9%
40 6%
20 3%
0 0%
2010 2011 2012 2013 2014 2015 2016
Mortgage funds held by insurance groups - Securitised by insurers - Source: DNB
non-securitised loans held by insurers or third parties
Bank subsidiaries of insurance groups - Insurers - non-securitised
non-securitised loans Percentage of total mortgage debt related
Securitised by bank subsidiaries of insurance groups - to insurance groups (right-hand axis)
held by those bank subsidiaries or third parties
risk only in Belgium, Germany, Croatia and the UK, was about 2.5 times larger. There was however
according to EIOPA figures. At 4% to 5% the rate unmistakable growth in Belgium and the UK.
in these countries was still well below that in the
Netherlands, where the share invested in mortgages
8 In order to prevent double counting Figur 3 securitised loans which, despite the fact of being securitised,
still appear on the balance sheet of the initiator, were not included in the categories of securitised by bank
of insurance group and securitised by banks.Loan markets in motion Box 1 Institutional investors on the mortgage market in a historical 15 perspective The past decades saw a sharp decline in the market share of institutional investors in the Dutch mortgage market. In the fifties, institutional investors and mortgage banks were the main funders of mortgages, and savings and agricultural credit banks also had modest activities in the mortgage market (see Figuur 4). Market boundaries blurred in the following decades: commercial banks entered the market, and savings and agricultural credit banks rapidly expanded their activities in the mortgage lending market. The enormous growth of mortgage debt was mainly financed by banks. Their market shares soared during the years of economic boom and buoyant housing markets. Remarkably, the market share of institutional investors climbed modestly again in economically less favourable times. The market share of banks has grown sharply over the past decades as a whole. In addition to blurring industry boundaries, there are other possible explanatory factors for this pattern: the large elasticity of bank balance sheets relative to institutional investors, the reduction of the bank capital requirements for mortgage loans, and the sharp increase in international diversification of the assets of institutional investors. Banks were able to extend their balance sheets relatively easily, as they operate with a large and in time growing leverage, have a money-creating character, and their access to wholesale funding improved, especially during the nineties. The increase in leverage was also enabled by the easing of capital requirements for mortgage lending activities of general banks. Capital requirements were eased particularly in 1977 and in 2007, when Basel II came into effect. And finally, the proportion of institutional investors also fell as they increasingly invested abroad.
Figure 4 Historic breakdown of mortgage debt outstanding
Market share % GDP
100 120
16
100
80
80
60
60
40
40
20
20
0 0
50 55 60 65 70 75 80 85 90 95 00 05 10 15 50 55 60 65 70 75 80 85 90 95 00 05 10 15
year year
Source: DNB.
Institutional investors General banks (commercial and agricultural banks)
Mortgage banks & savings banks House prices below previous peak
Figure 5 Institutional investors are concentrating on mortgages with
long fixed interest rate periods⁹
EUR
16
14
12
10
8
6
4
2
0
0 - 1 year 2 - 5 year 6 - 10 year 11 - 15 year 16 - 20 year 21 - 30 year
Mortgage funds (main investors pension funds) Life insurers Bank subsidiaries of insurance groups
Pension mandates Non-life insurers Banks
Source: DNB.
9 The figures stated in Figure 5 do not include foreign players.Loan markets in motion
There are substantial differences between bank Besides this, the percentage of mortgage loans 17
mortgage loans and those funded by institutional covered by the Dutch National Mortgage Guarantee
investors. Insurers and pension funds currently scheme (Nationale Hypotheek Garantie -NHG) is about
mainly finance mortgages with long fixed interest twice as large with pension funds and insurers as
periods of twenty years. They have large market it is with banks (see Figure 6). The percentage of
shares in this segment (see Figure 5). The shorter NHG-covered mortgage loans has, however, fallen
maturities are still dominated by banks. in recent years, due to the lowering of the NHG limit
and rising house prices.
Figure 6 NHG mortgage loans figure relatively large in the portfolios
of institutional investors
Proportion of new production originated under NHG
100
90
80
70
60
50
40
30
20
10
0
Banks Bank subsidiaries Life insurers Mortgage funds Pension
of insurance groups mandates
2012 2013 2014 2015 2016 Source: DNB.18 The margins on new mortgage loans are under rate periods up to five years have remained fairly
pressure at banks, partly due to increasing stable (see Figure 7 on the left). Margins mainly
competition. Gross margins at banks on new contracted in the segment where pension funds and
mortgage loans with fixed interest rate periods of insurers have large market shares, especially in 2014
more than five years have been shrinking since 2014, and 2015, when many pension funds started building
while those on mortgage loans with fixed interest up or expanding mortgage portfolios (see Figure 2).
Box 2 Gross margins on new mortgage loans at banks
This box visualises margins on newly originated mortgage loans (including interest renewals) at banks
in two different ways (see Figure 7). The margins depicted in both figures are gross margins, i.e. before
deduction of costs. These costs for instance include operating costs and credit risk and early repayment
costs.
Chart A shows the margins as the differential between the interest rates on new mortgage loans in a
particular fixed interest rate period segment, and the average fee that banks pay on their funding mix.
The banks’ mix of funding sources is a combination of wholesale funding, savings deposits, and other
sources such as central bank funding and shareholders’ equity. The maturity distribution of funding
sources has not been adjusted to that of mortgage loans here. Chart A shows that gross margins
at banks on new mortgage loans with fixed interest rate periods of more than five years have been
shrinking since 2014, while those on mortgage loans with fixed interest rate periods of up to five years
have remained fairly stable. If we were to correct for maturity, the margins in the long segment would
be lower, but the contraction would not by definition have been more pronounced. This would only
have happened if the funding costs for the longer maturities had outpaced the average.
Chart B shows the average margin on all newly originated mortgages as the differential between
mortgage interest rates and deposit rates, adjusted for the maturity differential in savings and deposits
by subtracting the two and seven-year swap rate (see also the Autumn 2016 edition of the OFS). >>Loan markets in motion
19
Chart B also reveals that the margin on the aggregate of all newly originated mortgage loans has
remained pretty stable. This is attributable to the shift of mortgage loans towards longer fixed
interest rate periods, where margins are higher than in the short segment (see Chart A).
This shift offsets the margin contraction in the shorter maturity segments.
Figure 7 Gross interest Margin on new bank mortgage loans
Chart A Chart B (OFS, Autumn 2016)
Gross margin (%) Gross margin (%)
3.5 3.5
3.0 3.0
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
07 08 09 10 11 12 13 14 15 16 07 08 09 10 11 12 13 14 15 16
Fixed interest, 0 to 5 years Interest margin on total loans extended
Fixed interest, 5 to 10 years
Fixed interest, more than 10 years Source: DNB.20 2.2 Causes Several aspects have made entry to the Dutch
mortgage market more attractive. Mortgage loans
The current low interest environment plays a have increasingly grown into a standard product
role in the increased activity of non-bank players owing to several developments: the lowering of the
in the mortgage market. This low interest rate Loan-to-Value (LTV) limit; the tightening of income
environment has created additional incentives for requirements and the tax incentives for repayments
pension funds and insurers to look for investments on new mortgages. At the same time, the
with attractive yields, limited risks and relatively Netherlands has always had a relatively large number
low capital requirements. From this perspective,
10
of independent mortgage advisers, which eases
mortgage loans are seen as an attractive investment entry for new lenders. And we should also mention
category, with relatively stable yields that are above the ongoing specialisation by the service providing
government bond yields. This is partly due to the companies, thanks to which new entrants to the
illiquid character of investments in mortgage loans; mortgage market can separately outsource various
pension funds and insurers are relatively well- tasks, e.g. administrative service and origination.
positioned to to bear this illiquidity risk, owing to
their long investment horizons.11 At the same time, Changing supervision frameworks are also
investors are showing growing confidence in the responsible for the observed shifts. Capital
Dutch mortgage market, thanks to the recovery of requirements for banks have been tightened over
the housing market and low losses on mortgages, the past years, both with respect to the quantity
also during the recent crisis years. In addition, and the quality of capital they are required to
as interest rates are low consumers are increasingly maintain. There are for instance more stringent
opting for mortgages with longer fixed interest capital requirements and stricter quality criteria
rate periods.For pension funds and insurers this for capital instruments. Banks are also required
is a relatively attractive market segment as these to maintain additional buffer capital on top of
mortgage loans match the long-term character of the minimum capital requirements, and they
their liabilities.
10 A drop in interest rates in itself is no reason for investment policy changes for insurers and pension funds: the
trade-off between risk and return is always there, regardless of the level of interest rates. Amid low interest
rates, the returns required to meet obligations will also fall; investments only need to yield small returns to keep
the solvency position up to standard. The current low level of interest rates may, however, play an indirect role
in the increase in investments in mortgage loans made by pension funds and insurers. If the solvency position
has deteriorated due to fallen interest rates, it may create pressure to invest in relatively more risky instruments
that require relatively low capital.
11 The level of illiquidity premiums is difficult to establish; due to lack of data, little research has been done into the
level of this risk premium for the most illiquid markets.Loan markets in motion
Figure 8 Capital requirements of requirements. As a consequence of these proposals 21
non-securitised mortgages for banks, the capital requirements for mortgage loans may
insurers and pension funds.12 rise to above those for pension funds and insurers
Percentage (see Figure 8 and Box 3). This applies especially to
mortgage loans with loan-to-value ratios of more
100
than 80%. However, capital requirements do not
80 seem to play a dominant role in the composition
of mortgage loan portfolios. For instance, pension
Risk weight
60
funds and insurers invest relatively often in NHG
loans (see Figure 6), investments that have the same
40
solvency capital requirement for these players as
20 loans without NHG. Banks originate relatively few
NHG mortgages, while their capital requirements
0
50 75 100 125 150
are lower for this type of loan.
Loan-to-value
Regulatory frameworks also influence the way in
Banks Standard Formula - Current
which investments in mortgage loans are made.
Banks Standard Formula -
New Basel consultation proposal The regulatory frameworks for banks (Basel III)
Banks Internal Model - Current and insurers (Solvency II) take a relatively strict
Insurers - Standard formula approach to securitisations. This means that capital
Insurers - Internal Model
requirements for investments in a portfolio of
Pension funds Source: DNB.
non-securitised mortgage loans are lower than for
investments in the same portfolio of of securitised
loans. It explains the sharp growth of non-
must comply with a minimum leverage ratio and securitised mortgage investments and the decline
liquidity requirements. The Basel Committee is in investments made by institutional investors in
currently working on proposals for new capital mortgage securitisations.
12 The comparison relates to mortgages that are not covered by the NHG. The line of Banks SA Basel 3.5 relates to the
consulted Basel 3.5 proposal. The scenario-based capital requirements for pension funds and insurers have been translated
into risk weights by assuming a “bank” capital requirement of 12.5%. When calculating these risk weights, assumptions were
made for insurers and pension funds: a 50% reduction was assumed for insurers, owing to diversification benefits and tax
deductible losses, and a 40% reduction for pension funds for diversification.22 Box 3 Capital requirements for mortgage financing by sector
The regulatory frameworks of banks on the one hand and pension funds and insurers on the other cannot
be easily compared as the composition and the nature of the capital requirements varies between the
different frameworks; in particular, take the difference between the largely book value based framework
for banks and the market value based framework for pension funds and insurers. The difference between
risk weights in capital requirements for banks versus scenario-based capital requirements for insurers and
pension funds should also be taken into account. The rough comparison reflected in Figure 8 shows how
the capital requirements for non-securitised mortgage loans without NHG differ.
Under Solvency II, which came into effect on 1 January 2016, insurers are required to hold capital for
mortgage loans, whereas they were not obliged to do this before. Capital requirements rise more sharply,
especially for the higher LTVs, than they do for banks under the current internal models. For lower LTVs
(up to about 75%) capital requirements for insurers are lower. Figure 8 shows higher capital requirements
for insurers with internal models than under the standard formula. In practice, capital requirements for
insurance with internal models are lower as they are allowed to use a dynamic volatility adjustment
that dampens the total capital requirement. This advantage cannot be modelled without access to all
investments, which is why it is not reflected in Figure 8.
With the implementation of the revised Financial Assessment Framework (nieuwe Financieel
Toetsingskader - nFTK) in the Netherlands, pension funds have been faced with heavier capital
requirements, but their investment allocation decisions are less driven by capital requirements than
they are at banks and insurers. For pension funds, required own funds for mortgage loans have risen
by roughly 40% since the introduction of the nFTK on 1 January 2015. They are, however, allowed under
certain conditions to hold less than the required own funds over several years. This may make capital
requirements less decisive for pension funds than for insurers and banks.
The comparison of capital requirements is fundamentally different for loans without NHG. Whereas
capital requirements for loans with NHG is hardly or not at all lower for pension funds and insurers,
capital requirements for banks are lower for these loans. For banks using the standard approach, capital
requirements are substantially lower for loans with NHG than for those without; banks using internal
models for NHG loans also have lower risk weightings, but the difference is less pronounced than under
the standard approach.Loan markets in motion
Differences between banks, insurers and pension account for a substantial proportion (15%) of 23
funds justify differences in regulatory requirements. 13
their investments and the life insurance sector is
Banks, insurers and pension funds compete in expected to shrink. Pension funds on the other hand,
the loan markets, but are governed by different still have scope for substantial expansion of their
regulatory framework with varying regulatory investments in the mortgage loan market in the
requirements. This may beg the question whether short term, as they currently have less than 2% of
we can speak of a level playing field. Banks, insurers their assets invested in mortgage loans. The biggest
and pension funds, however, have fundamentally funds in the pensions sector have to date been
different business models and concomitant balance relatively reluctant to invest in Dutch mortgage
sheets and risks. A comparable mortgage loans loans. As the largest pension funds together invest
portfolio on the balance sheet of a bank carries the bulk of Dutch pension assets, their investment
different balance sheet risks than it does on the policies strongly determine the extent to which
balance sheet of an insurance company or pension total pension fund investments in mortgage loans
fund. Moreover, banks must be able to absorb a grow. Consequently, this outlook has two growth
sudden outflow of funds and savings. However, scenarios (see Box 4). In scenario 1 only pension
some of the differences that may exist between funds that are already investing substantial amounts
the regulatory frameworks cannot be explained in mortgage loans will increase their mortgage
by intrinsic differences between the types of portfolios. Scenario 2 assumes that all pension funds
institutions. DNB aims to counteract cross-sectoral will allocate a substantial proportion (10%) of their
inconsistencies in those cases where differences assets in mortgage loans, see Figure 9.
cannot be explained on prudential grounds.
This serves to prevent regulatory arbitration and Despite such further increases in mortgage
contributes towards creating a level playing field. investments by Dutch institutional investors,
the share of bank lending and funding from abroad
may rise (again) in the longer run. If policy remains
2.3 Outlook unchanged, Dutch mortgage debt is expected to
continue rising (see Box 4). Until 2020, the expected
The future size of mortgage investments of growth of mortgage debt may be accommodated
institutional investors will be mainly determined by by additional investments in mortgage loans by
the investment policies pursued by pension funds. pension funds and insurance groups. But after 2020
For insurers, the scope for expansion in mortgage this is no longer the case, even in scenario 2, with all
loans seems limited as these loans currently already pension funds entering the mortgage loan market
13 See also DNB (2015a), Differences between banks, insurers and pension funds justify differences in
supervision, DNBulletin, March 2015 on www.dnb.nl24 Figure 9 Growth of mortgage investments by institutional
investors vs growth of mortgage debt¹⁴
EUR billion
250
200
150
100
50
0
2016 2020 2025
Insurers - share of mortgages in investments grows to 25% in 2025
Bank subsidiaries of insurance groups - Mortgage portfolio increases to EUR 50 billion in 2025
Pension funds in scenario 1 - share of mortgages in investments grows to 5% in 2025
Pension funds in scenario 2 - share of mortgages in investments grows to 10% in 2025
Growth in mortgage debt - upper limit of projection
Growth in mortgage debt - lower limit of projection Source: DNB.
on a large scale (see Figure 9). Banks will therefore intermediary, whereby banks continue to dominate
continue to play a dominant role in the mortgage mortgage loan origination without keeping these
market, but a rise in capital requirements for loans on their own balance sheets by means of
mortgage loans may lead to shortening of balance third-party financing. Foreign parties seem to be
sheets at banks. If this happens, the role played showing growing interest again, but their role is still
by banks would increasingly shift towards that of relatively small. Their activity in the Dutch mortgage
14
Figure 9 shows the change for the years 2020 and 2025 compared to 2016. No projection has
been made for the years between 2016 and 2020 and the years between 2020 and 2025.
For these years in between the projection has been linearly interpolated to graphically
represent the developments over time.Loan markets in motion market used to be short-lived. The extent of interest loans. The European Commission’s capital market 25 shown by foreign lenders depends on market initiatives include lower capital requirements for liquidity and ongoing standardisation of mortgage simple, transparent and standardised securitisations. Box 4 Simulation of growth of mortgage debt and mortgage investments made by institutional investors In order to determine which role institutional investors could play in the near future, we have compiled two growth scenarios for mortgage investments made by these investors until 2025. The two scenarios are not predictive, but reflect the consequences of increasing mortgage investments by insurance groups and pension funds for the overall mortgage market. In our projection, insurers will see shrinking balance sheets in the years ahead, due to slumping sales of new life insurance policies, while the nominal balance sheet size of pension funds will remain unchanged, due to various factors including the growing proportion of self-employed people and the increasing number of retired members. In both scenarios, insurers will lift their allocation to mortgages to 25% from 15%; bank subsidiaries of insurance groups will increase their mortgage portfolios by 60%. The two scenarios differ in the extent to which mortgage investments of pension funds are expected to grow. Scenario 1 assumes that only pension funds that already have substantial investments in mortgage loans will increase their allocation to 10%; the other pension funds will keep their allocation to mortgages unchanged. The average investments made by pension funds in mortgage loans will then rise to 5% from 1.8% of total investments. In scenario 2 growth will be stronger as all pension funds are now investing in mortgages: the mortgage investments of all pension funds will rise to 10% of total investments. In addition to this, DNB has made a projection of nominal growth of Dutch mortgage debt assuming that mortgage and housing market policies remain unchanged. Mortgage debt is projected to grow to EUR 800 billion to EUR 875 billion in 2025, from EUR 662 billion in mid-2016. As a percentage of GDP mortgage debt will not necessarily grow, as nominal GDP is also expected to grow. The rise of mortgage debt is due to various factors, including projections of the increase in the number of owner- occupied houses, the rise in house prices, and the difference between the average amount borrowed by first-time buyers and that borrowed by home owners exiting the market who were able to buy a home at much lower prices in the past. DNB expects that this will in the medium term outweigh the downward impact of the LTV reduction and the increase in mortgage repayments. The simulation also takes account of trends in the population size and the composition of households.
Loan markets in motion
3 Corporate
lending market
3.1 An analysis of shifts (2015a) confirms the trend that an increasing 27
number of businesses no longer want to depend
For Dutch businesses, bank lending is the main on a single funding source: 40% of businesses
source of debt financing. An estimated 80% of SME queried indicated that they intended to use bank
businesses relies on bank lending. Virtually all (95%) loans in the next two to three years. This was still
of businesses are micro businesses15 that due to their 70% in 2011, and there is a remarkably strong rise in
size have hardly any access to the capital market preference for funding by means of external equity.
and are therefore obliged to turn to bank lending.
Bank lending to Dutch businesses has, however, In recent years large companies have largely
fallen since 2010, with the sharpest declines in replaced bank lending with the corporate bond
lending to the commercial real estate sector (Box 5). issurance. In six years’ time, the volume of publicly
trade debt paper outstanding jumped by more
Although the corporate lending market is showing than half to EUR 141 billion.17 An analysis made by
shifts towards non-bank lenders, they are mostly Meyer et al. (2014) shows that during the crisis
constrained to large companies. The proportion years, banks opted to lead businesses in issuing
of bank lending in corporate debt financing has bonds rather than originating syndicated loans.
fallen by over five percentage points since 2010. The announcement of the ECB’s corporate sector
Both supply and demand effects play a role here purchase programme in the spring of 2016 fuelled
(CPB, 2015a; CPB 2015b; OESO, 2014). While large the issuance of corporate bonds. Some 40% of the
companies increasingly prefer to fund themselves by rise in corporate bond issues took place after the
issuing corporate bonds, alternative SME financing programme was announced. ECB 2016 calculations
sources, e.g. SME funds and crowdfunding are show that the announcement of the purchase
still niche markets (see Figure 10).16 So there may programme roughly explains two thirds of the
be large growth potential for market financing of decline in the spread between yields on investment
SMEs. A recent survey by the European Commission grade corporate bonds and the risk-free rate.
15 The SME sector can be broken down into micro businesses (less than 10 employees), small companies
(between 10 and 49 employees) and medium-sized companies (between 50 and 249 employees). Large
companies have more than 250 employees.
16 Figure 10 shows bank lending adjusted for securitisations and cash pooling. As no ful data sets are available
for all new funding sources, we have only taken into account crowdfunding, SME stock market NPEX,
Bedrijfsleningenfonds (corporate loan fund) and MKB- Impulsfonds (SME impulse fund). The first four forms
of funding mentioned are based on amounts invested. In order to produce a transparent overview, figure 10
does not include loans originated by non-financial institutions and non-domestic sources.
17 End Q2 2016.28 Figure 10 Overview of shifts in corporate financing18
Outstanding debt in 2010 in EUR billions Outstanding debt in 2016 in EUR billions
18.8 0.04 4.9 0.7
5.5 11.8
89
141
294 267
Bank loans Securitisations
Coporate bonds New alternatives
Private placements
Source: DNB, CBS, Dealogic, Douw & Koren,
NPEX, Qredits and VSK/VKN.
Corporate bonds are an increasingly attractive enterprises only. Owing to the issue activities of
funding source for internationally operating large roughly ten enterprises, the outstanding volume of
corporates. By way of illustration: corporate bonds private placements has more than doubled to over
account for almost one quarter of total debt EUR 12 billion (Figure 11). In contrast to corporate
financing, a seven percentage point increase relative bonds, private placements issues do not need an
to 2010.18 The number of businesses taking recourse official credit rating and issue costs are lower.
to the bond market is modest, however: ten Dutch The private placements market is expected to
businesses account for about 80% of corporate remain accessible for a small number of large and
bond issues since 2012. medium-sized companies only, due to the average
size of private placements and the concomitant
The private placements market is on the rise, but reporting requirements. (OECD 2015). Various
seems to be an attractive funding alternative studies have shown that investors only benefit from
for a small number of large and medium-sized investing in this market by making investments of
18 End Q2 2016.Loan markets in motion
Figure 11 Market for Dutch private placements is on the rise 29
Amount outstanding at end Q2 2016
14
12
10
8
6
4
2
0
94 96 98 00 02 04 06 08 10 12 14 16
Private placements (issued in EUR)
Private placements (issued in USD)
Private placements (issued in other currencies) Source: Dealogic.
at least EUR 20 million (Banque de France, 2015). dozen peer-to-peer platforms in the Netherlands,
Dutch enterprises prefer the US market to the fourteen of which have AFM authorisation as
fragmented euro area markets: about 80% of the investment or financial services firm. Other forms
total amount outstanding in private placements is of financing such as credit unions (EUR 4 million)
denominated in US dollars. and micro credits (EUR 42 million), also continue to
be niche markets. These new instruments account
Although alternative financing sources for small for only a fraction of bank lending to the smaller
and very small companies are growing rapidly, business segment (< EUR 250,000) and hardly
they still account for only a fraction of the total counterbalance the contraction of bank lending
supply of funding. Whereas in 2011 less than to small businesses seen in the past few years.
EUR 1 million was borrowed by means of peer- On the one hand, this is attributable to the fact that
to-peer lending, this had risen to EUR 92 million businesses are still relatively unfamiliar with these
in 2015 (Douw & Koren, 2016). There are several new forms of financing, and on the other, it may be30 difficult for alternative funding sources to match
supply and demand, which limits their chance of
success (Deloitte 2014). Traditional alternatives such
as leasing and factoring are relatively expensive and
consequently of no use for small businesses (CPB,
2015a; Panteia, 2013).
Box 5 Lending to the real estate sector
Since the end of 2010, bank lending to the commercial real estate sector has declined by over one third
to around EUR 62 billion in the second quarter of 2016. Two third of this amount was accounted for
by loans to the Dutch real estate sector. At a little over 3%, the joint commercial real estate portfolio
of the large Dutch banks may be relatively small compared to their total balance sheet size, but it is
risky (around 10% of total risk weighted assets). Banks have become reluctant to extend loans to the
commercial real estate sector, due to the difficult market conditions and the tight liquidity positions of
commercial real estate companies. The tightened capital requirements for banks also play a role. At the
end of 2010 almost one in three bank loans was outstanding to this sector, which has by now fallen to
one in five bank loans outstanding.
Besides reducing their lending operations, Dutch banks divested almost EUR 4 billion in real estate
portfolios between 2012 and 2015 (CBRE 2015). In 2016, another EUR 6 billion will be added to this
amount (Deloitte 2016). Banks are expected to continue divesting their real estate portfolios in the
years ahead, as they are committed to reducing their risk weighted assets. For the buyers – mostly
US and to a lesser extent UK investment funds – the favourable Dutch insolvency laws and the low
percentage of defaults in a European perspective outweigh the considerably illiquid real estate market
with relatively high vacancy levels.Loan markets in motion
3.2 Obstacles Figure 12 Dutch institutional 31
investors only originate a modest
Various forms of market failure have adversely
number of corporate loans
affected non-bank financing of SMEs. First of
Share in outstanding volume of corporate
all there is information asymmetry, meaning loans at end Q2 2016.
that the costs possibly outweigh the proceeds
38.9% 9.2%
of investments. Smaller companies in particular
are often unable to provide full insight into their 8.7%
0.9%
financial position, due to the relatively high costs
1.4%
involved. This makes it relatively laborious to assess
the creditworthiness of SMEs and by extension
the quality of credit portfolios. Moreover, investors 0.5%
and institutional investors do not always have the
41.8%
capacity to analyse the creditworthiness of SMEs,
meaning that they are unable to assess the value Foreign Other
Banks Insurers and
of their investment (Crawford et al. 2015). pension funds
Other financial
institutions Investment funds
Figure 12 shows that Dutch institutional investors
Source: DNB, Statistics Netherlands.
only play a modest role in originating corporate
loans. The IMF in 2014 advised that establishing
a credit register for SMEs may in the longer
term increase transparency and the quality of US private placement market is largely explained by
credit information, which makes it easier to the standardisation of loans documentation and the
attract funding. role played by the National Association of Insurance
Commissioners in the credit assessment of these
Secondly, the lack of standardisation in reporting loans. The Bank of England and the ECB (2014)
and loans documentation increases monitoring argued earlier that the ongoing standardisation of
costs for investors and institutional investors. SME loans may provide a solution for the variations
Corporate loans are very diverse as businesses differ in securitised SME loan portfolios, which makes it
strongly in size and legal form, the type of collateral easier to analyse credit risk at portfolio level.
they use and the form and seniority of the loans that
they take out. The OECD (2015) and the EC (2015b) Thirdly, the lack of liquidity and large-scale
contend that the private placement market in the initiatives makes it difficult for Dutch companies to
euro area is faltering due to lack of standardisation. raise funding directly with investors and institutional
The OECD (2015) believes that the success of the investors. The fragmentation of financial markets32 in the euro area is curbing the marketability and The smaller the company, the fewer financing
liquidity of securities. A 2016 CEPS report mentions channels it can access. More often than not, micro
fragmentation as one of the main causes of the ever businesses apply for credit lines at their own
growing funding gap especially with the booming bank rather than turning to alternative suppliers
medium-sized segment in the euro area that is (ACM 2015). At the same time, the technological
looking for low-cost and stable sources of funding. developments of the past few years (e.g. credit
In addition, investments demand a certain minimum approval fully based on algorithms) have enabled
size. The SER (2014) believes that large scale a new and rapidly growing group of fintech
initiatives are necessary (investment volume of companies to enter the online loan markets. Thanks
> EUR 1 billion) to make SME loans attractive as to their high-grade IT systems and the scale of their
an investment category for institutional investors. services, fintech companies are sometimes able to
This is because investments of a substantial size operate at lower costs than banks can. Businesses
justify the transaction costs involved and make are gradually familiarising themselves with these
benchmarking easier. These investors are expected new forms of funding, however. A survey held by the
to fit small-scale initiatives into their current private Dutch Chamber of Commerce in 2015 for instance
equity and credit mandates. revealed that crowd funding is in the top five of
financing forms that are being considered, but that
The SME segment – small companies in particular – only 1% of businesses had actually used it.
does not have sufficient equity and collateral to
cushion market failure. As it is difficult for non-bank
investors to monitor businesses, these businesses 3.3 Outlook
are required to bring in sufficient own funds in order
to be able to raise market funding. Various market Various investment funds are being introduced
studies have, however, revealed that a part of the to lower the barrier to entry to market financing
SME segment – small companies in particular – are for SMEs. Investing through investment
struggling, both economically and structurally (CPB funds is an attractive option for institutional
2014). The smaller the business, the fewer assets it investors looking for investment projects of a
has that can be pledged. In a bank-based system certain scale. The establishment of the Dutch
it is easier for businesses with lower own funds to Investment Institution has led to the creation
receive bank loans. Banks often have long-term of two funds for SMEs: the corporate loan fund
customer relationships with businesses, meaning (Bedrijfsleningenfonds) and the subordinated loan
that they have better information and are able to fund (Achtergestelde leningenfonds) that facilitate
monitor risks more easily than other parties can. combined bank and fund financing. The total
On the demand side, SMEs seem reluctant to envisaged size of the two funds is EUR 1.3 billion.
explore new funding alternatives for bank loans. To date, institutional investors have investedYou can also read
