Mortgage Credit Insurance for Lenders

1. Mortgage Credit Insurance for Lenders Loїc Chiquier OPD, Housing Finance Business Group November 11, 2005

2. Purposes Specialized form of credit insurance that protects home mortgage lenders against loss by reason of borrower default (unable or unwilling) • Expand affordability: less down payment (0%-20%), incentives for lenders to underwrite riskier loans • Increase homeownership, stimulate more and sounder lending • Useful external credit enhancement for mortgage securities • Can improve market efficiency / and credit risk management • 30-35 countries: mixed results, decisive operational issues • Compare with other HF affordability mechanisms: subsidies, housing savings, residential leasing, housing microfinance, etc. MI is not a subsidy, may not directly lower credit rates

3. Specific Products • Specific long term exposure to real estate cycles • Specific risk management functions and regulations • Variants: credit standards, coverage, claim payments, public/private partnerships, individual credit vs. pool, etc. • Factors: housing markets, macro conditions, credit products and standards, market infrastructure (property titles, rental markets, mortgage foreclosure, appraisal, credit information, available data) • Need to manage adverse selection by lenders • Should not cover for inefficient infrastructure, fraud, natural disasters, political risks (at least private industry)

4. International Examples (I) • US FHA: Long-term FRMs to moderate/low income groups (high cover, high LTV) to enhance credit affordability, 1990 crisis • US private MIs (credit risk management, LTV franchise for MBS) the industry (now 8) went through severe stresses in the 80’ • Canada: public CHMC, high cover & LTVs, set credit norms, former monopoly, LTV franchise, catastrophic state reinsurance for all MI • Australia and UK: private competing MI industry to manage high LTV risks and enhance securitization (quite efficient) • Israel: private MI for enhanced affordability (UGI subsidiary) • Mexico (public SHF) first loss limited cover, actuarial pricing, contracted private US reinsurers (70%), 100,000 loans • Kazakhstan – state owned MI to extend credit affordability • HKMC developed MI window through unused public capital (limited MBS), 80% reinsured by private insurance, LTV 70% franchise • Perceived as premature in Russia in 2004

5. International Examples (II) • Lithuania: public MI, cover down to 25%, high LTV, actuarial approach, Govt pays 50% premium for social loans, limited market • Colombia: new Guarantee Fund focused on social housing loans, standards discussed with securitization company, plus separate state guarantee for mortgage securities backed by social loans • Chile: social H. Profiv (replace expensive system of subsidies) • Morocco: sluggish use of new public fund although subsidized • Hungary: public fund (subsidy), possible private for mortgage bonds • France: just canceled FGAS (disappointing impact but high costs) • Insolvent funds in Sweden ($1 billion) and Philippines (National Housing Guarantee Corporation: subsidies, unpaid claims), Brazil (FCVS to cover macro risks of indexed mortgages) • Mali: promising albeit small development (dependency on 1 lender) • China: 80 local funds, need to create a effective national system

6. Preconditions for success • Reasonable macroeconomic, and political stability • Contract enforceability, credit payment culture, functional titles & liens • Data availability and reliability (mortgage, credit, and property) • Efficient housing markets • Sizeable, efficient and competitive lenders • Effective supervision for lenders and insurers • Market justification and needs for lenders and/or issuers • Threshold business volume at least for private sector

7. Lessons • Similar operations and regulations for private and public insurers • Actuarially sound premiums and reserves • Monoline regulatory framework • Share risks with borrowers and lenders (% LTV, % cover) • Risk management skills • Independence from political pressure • Scale and risk diversification (neither fragmentation nor monopoly) • No excessive state contingencies, no indirect subsidies • Adjust products to the market demand (cover vs. price) • Reduced capital and loan-loss provisions rules for lenders

8. Possible Forms of Government Sponsorship • Share risks as much and as soon as possible with private industry • But state may pioneer the development of a MI industry as part of broader HF reforms when market still untested/small -> private reinsurance -> private MI (sunset for state) • Avoid state concentration of credit risks (poor infra and risk mngt) • Different risk sharing arrangements • Public and private co-shareholders (India?) • Public fund focused on social housing, private on middle-income • State paying for part of the premiums for social housing • Catastrophic risk retained by state (Mexico: macro risk through swap), Netherlands (more general guarantees)

9. Sociedad Hipotecaria Federal (SHF) Mexico:State Sponsored MI as market catalyst • Part of broader reforms to develop affordable and sound mortgage markets (housing policy, foreclosure, etc.) • New MI program (2004) to push for higher LTV and enhance MBS • Indexed UDI and pesos loans, 25% first loss cover, >65% LTV • Sold to banks and non banks lenders (sizeable program by now) • Actuarial pricing (80-100 bp spread) and large capital reserves • Premium rates based upon Mexican portfolio experience • Needed risk-based capital regulations to encourage lenders • Major technical efforts (score system, IT, risk model, underwriting standards) not be under-estimated • Program designed to be reinsured in the US (70%) as first step • Then MI legislation: private MI, continuing role for SHF insurance • Prior failure of another public program in 90’ (“pari passu”)