Transcript view presentation here - Asia Pacific Union For Housing Finance

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
Housing Finance Program Coordinator
[email protected]
The World Bank
Financial and Private Sector Development
GCMNB
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
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
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for low income housing finance
THE CRISIS
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Securitization – Basic Structure
Individual Mortgages
Originator
MBS
SPV
Investors


AAA
AA/A
AAA

(independent SPV, originators
relinquish control over assets)
AA/A

BBB
Portfolio sold to a Special
Purpose Vehicle
Bankruptcy remoteness
Condition: “True Sale”
BBB
Investors’ direct exposure
on the portfolio  various
degrees of protection (credit
BB-B
BB-B
enhancement)


Restructuration of cash
flows
Issuance of bonds with
different profiles (tranches)
Securitization structures did not withstand the subprime
debacle
Water Fall Allocation
(allocation of
principal)
AAA
A1 A2 (IO) A3 (PO) A4
AA
M1
A
ABBB
BB +
BB
BBFirst loss
M2
M3
M4
M5
M6
M7
OC, Excess Spread
Equity

of losses
A5

16%

4%
(Credit enhancement)
Residual
(ex post)
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
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Re-securitization : a major contagion vehicle
AAA A1 A2 (IO)
AA
A
ABBB
BB +
BB
BB-
A3 (PO) A4 A5
M1
M2
M3
M4
M5
M6
M7

CDO
Rating Equity
Mix
Credit AAA
enhance Leverage
ment


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
CDO²
Residuals
M1
M2
M3
M4
M5
M6
M7
CDO
Rating Equity
Mix
Credit AAA
enhance Leverage
ment
Second, or third level
structures, based on
leverage and rating arbitrage
Credit enhancement created
an illusion of safety :

Leverage mostly short term
(credit, ABCP), based on
another illusion among
investors - banks, money
market funds- : a AAA paper
would always be liquid
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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

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THE GOVERNMENT
SPONSORED ENTERPRISES
CRISIS
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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)
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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:
3.

investments in private MBS

relaxation of underwriting criteria and support of Alt A segment (# FHA)
Weak regulation and oversight



Low capital adequacy requirement
Relaxation of some accounting standards (NPL)
Weak supervision (close ties with the specialized supervisor)
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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
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RESTORING THE MARKET THE ROLE OF GOVERNMENTS
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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



2)
Quality standards
Due diligence and post-issuance verification by third parties
Exposure retention by originators to align incentives
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-tomodel)
 Value of a specialized agency to set standards, check and
certify compliance
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)
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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: SHF’s new strategic orientation
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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
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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
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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
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