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Securitizing Affordable Housing Loans: the Role of Governments Affordable Housing and Housing Finance South Asia Housing Finance Forum Delhi, January 27-28,

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Presentation on theme: "Securitizing Affordable Housing Loans: the Role of Governments Affordable Housing and Housing Finance South Asia Housing Finance Forum Delhi, January 27-28,"— Presentation transcript:

1 Securitizing Affordable Housing Loans: the Role of Governments Affordable Housing and Housing Finance South Asia Housing Finance Forum Delhi, January 27-28, 2010 Olivier Hassler The World Bank Housing Finance Program Coordinator Financial and Private Sector Development GCMNB 1

2 Securitization started as a government intervention tool (Freddy Mac, 1970s, to help Savings& Loans dire A/L mismatches) Explosion of structured finance in the last 10years Crisis and collapse of the market in the US, resulting in a worldwide disruption of securitization Still, an instrument needed to back long term maturities and fixed rate loans, critical for the soundness of housing finance and its affordability But the crisis was ignited in the subprime segment, often equated with low income Unfolded in the country where government related entities had remained major players, with a mandate to deepen the market (Fannie Mae and Freddy Mac, FHA/ GNMA). Lessons from the crisis and challenges to use securitization for low income housing finance 2


4 Securitization – Basic Structure Individual Mortgages MBS Originator SPV Investors Portfolio sold to a Special Purpose Vehicle Bankruptcy remoteness Condition: True Sale (independent SPV, originators relinquish control over assets) Investors direct exposure on the portfolio various degrees of protection (credit enhancement) Restructuration of cash flows Issuance of bonds with different profiles (tranches) BB-B BBB AAA AA/A BBB BB-B AAA AA/A

5 Securitization structures did not withstand the subprime debacle Multiple tranches/bonds (CUSIP) with different characteristics and behaviors Normally, credit enhancement increases over time since AAA bonds are repaid first Sub-prime/ Alt A 2005-2007: losses quickly exceeded credit enhancement (20% typical for subprime), overflowing on senior tranches 5

6 Re-securitization : a major contagion vehicle Second, or third level structures, based on leverage and rating arbitrage Credit enhancement created an illusion of safety : Either internal and overwhelmed by actual losses Or external (bond wraps) by monoline financial guarantors. Incurred large losses, leading to drastic downgrades and weakening of the support Leverage mostly short term (credit, ABCP), based on another illusion among investors - banks, money market funds- : a AAA paper would always be liquid 6

7 Uncontrolled surge of financial transactions Huge Transaction Volumes leading to Operational Deficiencies (USA and other developed markets) Explosion of claims within the financial system. Growth of MBS disconnected of the real economy (*4, or +27% p.a. 2000-07) Millions of mortgages, millions of bond tranches, re-securitization, illegible trustee reports Inability of rating Agencies to adequately assess and monitor all the bonds Lags and weaknesses of valuation models (e.g. use of CDS to price credit risk) Extreme Complexity of unregulated Capital Markets Products Sophistication of products – e.g. multiple tranches with specific behavior Intensive use of leverage to fund loans = quasi banking activity (shadow banking systems) …Without regulation Sudden awareness of opacity deep confidence crisis, especially towards LI mortgage lending, equated with subprime 7


9 The US GSE Model : Causes of F&F Demise Mission: Ensure and regularize the flow of resources towards mortgage finance Promote the access of underserved categories to housing finance (goal of +/- 50% set annually since 1992) Structure: Special legislative charter, private capital, HUD + OFHEO oversight Abyssal losses negative equity placed in conservatorship (Sept 08), 80% of capital held by the government Immediate factors: Support to Alt A loans Investments in MBS collateralized by subprime mortgages Although about 20% of MBS guaranteed or held, source of the majority of losses ; 60% of AAA MBS bought by F&F downgraded to junk (House Committee on Financial Services Report, June 2009) 9

10 F&F Model Structural Flaws 1. Assumption of whole credit risk (shared only for high LTV loans) Huge risk concentration 2. PPP model: misalignment corporate incentives / public mandate Capture of the implicit subsidy allocated to the entities: development of own portfolios ($1.8 Tln in 2004) to maximize its impact on profits Small share of the subsidy value passed on to end users (est. between 0 and 35 bp) FHA/GNMA crowded out (overall impact of the 3 agencies stationary ) Reaction to fall of market share (72% of all MBS in 2004, 57% in 2006) due to the growth of private label MBS: investments in private MBS relaxation of underwriting criteria and support of Alt A segment (# FHA) 3. Weak regulation and oversight Low capital adequacy requirement Relaxation of some accounting standards (NPL) Weak supervision (close ties with the specialized supervisor) 10

11 A more resilient mixed economy model : the Canadian MBS market MBS =29% market share (2007) Standards set since the 1990s by the Office of the Superintendent of Financial Institutions and the Deposit Insurance Corp.- emphasis on creditworthiness Financial Consumer Agency of Canada, est. 2001: a protection against reckless lending Bank Act: MI compulsory for mortgages > 80% LTV (75% before 07) In practice, 0% down-payment existed until 2008 (5% mandatory now) Government guarantee for MI, public (CMHC) or private (2 insurers), for a premium National Housing Act: CMHC guarantee of MBS (90% of MBS) All underlying mortgages must be insured Prevalence of portfolio lenders also an important factor 11


13 General Orientations to restart securitization Numerous on-going initiatives industry/regulators, national/international to restore markets and investors confidence: 1) Lending norms and origination practices Quality standards Due diligence and post-issuance verification by third parties Exposure retention by originators to align incentives 2) Enhance transparency : data, qualitative information standardized definition (LTV, DTI, etc.), accessibility 3) Regulate securitization structure: capital charges as a deterrent to re-securitization, leverage limitations 4) Enhance investors capacities : better education, valuation tools and accounting rules (problem of marked- to-market as well as marked-to- model) Value of a specialized agency to set standards, check and certify compliance

14 A possible model: Colombia Titularizadora Colombiana: Central private sector securitization agency Select originators and servicers Define lending standards and loan eligibility criteria, e.g. scoring Provides valuation model Acts as a master servicer Provides regularly market information Ensures transparency and allows investors confidence But government support critical for the success of securitization (30% market) : Conservative prudential framework Income tax relief for investors (not a sustainable factor) 14

15 Application to Low Income Housing Finance Lending norms: the assessment of repayment capacity of special importance: budget analysis maybe more important than DTI ratios Informal sector: Verification, or adequate estimation of income Assessment to be based on full interest/amortization rates if lowered initial payment phase Avoid excessive reliance on LTV, and on price appreciation expectation Importance of responsible lending and access to indebtedness information The recovery performance of servicers of the essence. Should be an eligibility criteria and a public information - Ex.(primary level credit enhancement); US FHA, Colombia Guarantee Fund Importance of supporting alternative lenders that finance underserved categories - Mexico: SHFs new strategic orientation 15

16 A promising experience? Micro Credit Securitization in Bangladesh Successful securitizations of BRAC micro-credits, incl. housing loans ($ 15Mln ) High performance history/credibility/information system of the originator Large credit enhancement: 50% Overcollateralization, 16% cash reserve, replacement of NPL, Importance of a rating agency (CRAB) with proportionate operational capacities Public support: FMO/KFW guarantee for Subordinated tranche 16

17 Credit Risk Sharing Arrangements Securitization is about transferring risks. Even if quality standards are warranted, investors reluctance to be exposed to LI credit risk will not recede easily given the subprime crisis External guarantees probably necessary beside internal credit enhancement. Unlikely to be developed without government support Danger: moral hazard resulting in uncontrollable fiscal contingent liabilities. Need of safeguards: Appropriated risk sharing with originators/servicers Premiums charged for the coverage Guarantees on portfolios, not to an institution Clear eligibility criteria and surveillance to ensure the desired targeting 17

18 Reconciling affordable loan profiles with investors demand Features of special importance for LI segments: slow amortization rate, prepayment option, stable payments, no exchange risk Investors may want short term instrument, – particularly if market liquidity is low-, predictable cash flows, a protection against capital depreciation (floating rate, indexation, hard currencies, etc.) Need of a buffer In the absence of hedging instrument, the government can sponsor reconciliation mechanisms. Ex.: Mexico: swap between different indices Colombia: equalization fund between short term rates and fixed real rate loans 18

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