Public and Private Partnerships in Mortgage Insurance: Lessons form Mexico’s SHF Experience Carlos Serrano Housing Finance in Emerging Markets Conference World Bank, March 2006 2 Contents I. Mortgage Insurance as a Key Element in Developing Housing Finance Markets in Mexico II. Government Role (SHF) in Developing a Mortgage Insurance Industry III. SHF’s Mortgage Insurance Product IV. Measures Taken to Incentive Entry from Private Sector Participants in the Mexican Market 3 I. What is Mortgage Insurance? • Mortgage Insurance is a financial product that offers risk coverage to the owner of a Mortgage Loan. Without MI With MI Downpayment 20% 5% Credit Outstanding 80% Bank Risk Downpayment 15% MI Risk 80% Bank Risk Credit Outstanding 4 I. Mortgage Insurance: Benefits • Improves origination quality of mortgages, promoting competition in price and quality (and not on relaxing credit origination criteria) • Improves servicing of mortgages by requiring servicers to follow loss mitigation procedures. • Incentives the creation, analysis and dissemination of high quality credit data. • Promotes higher quality in appraisals. • Promotes standardization in information and credit files. • Increases accessibility to housing finance by easing the conditions to grant low down payment mortgages and can eventually reduce interest rates. • Improves market liquidity by certifying mortgage quality to investors. • Attracts private capital to housing finance markets. 5 I. How does MI compare with other mechanisms to foster the development of mortgage markets? 6 I. Fostering Mortgage Insurance in Mexico Banks, Sofoles and Pools of Loans 1. 2. 3. Mortgage Insurers Mortgage Reinsurers SHF Specialized International Reinsurers Private MI Companies AHF Short Term: SHF offers MI and FGI cover, looking for reinsurance with specialized international insurance companies. Medium Term: Private insurance companies, including affiliates of international firms, offer cover for residential and medium segments of the market, while SHF offers cover for social housing and special risks not covered by private monoliners. Long Term: Private MI companies offer cover for all market segments, SHF offers reinsurance taking those risks private entities are not willing to hold. 7 II. Government Sponsorship for MI • Virtually all countries where MI exists have required Government support to create the industry. Evidence shows that it is extremely difficult for these industries to develop alone. In the United States, the first country to develop an MI industry, the product was first introduced by FHA, a Government agency. For these reasons, it was decided to offer MI from SHF and then to create the necessary conditions to attract private sector participants (described later in the presentation). • If MI is to be supplied from a Government institution, there is a need to design an exit strategy. Although the need for Government participation may never disappear; the poorest segments may not be attended by private participants, as the United States experience shows. 8 II. Government Sponsorship for MI SHF’s counts with Full Faith and Credit from the Federal Government for all its obligations assumed prior to the year 2013. The Full Faith and Credit has proven fundamental to give credibility to our MI product and to entice private sector participation to the industry. However, a clear sunset clause is also fundamental in order to: i) create discipline in the Government agency and ii) assure that there will be no unfair competition from the Government once private sector participants enter the market. • Assuming that Government participation is required, the agency in charge of supplying MI must be as isolated form the political process as possible. 9 II. Government Sponsorship for MI In the Mexican case, SHF is overseen by a seven-member Board of Directors of which one is the Governor of the (independent) Central Bank and two are independent form the Government (the rest are members of the Federal Government). • If a Government agency is a direct provider of MI, it must face exactly the same regulations that private firms face. SHF is now regulated as a Bank. A change to the SHF Law will be submitted before Congress in order to create a Mortgage Insurance subsidiary that will be regulated in the same terms as private sector entrants. 10 II. Government Sponsorship for MI • In addition to the measures described, Governments also need to take actions in order to incentive the acquisition of MI. In the Mexican case, the following measures have been adopted: Banking regulation provides capital relief to mortgages that count with MI. Capital requirements for loans with LTV>65% are 8% while for loans with LTV<65% are 4%; MI counts as downpayment in order to calculate LTV. Conforming Mortgage-Backed Securities receive favorable regulatory treatment. In order to me conforming, loans backing an MBS need to have MI. In addition, SHF will not provide its Financial Guaranty product for securitizations if loans do not count with MI. 11 II. Government Sponsorship for MI • A fundamental factor in order to have sound underwriting procedures for MI companies is to have reliable appraisals. Therefore, we think that, at least in initial stages, the appraisal industry must be regulated by the Government. 12 III. SHF’s Mortgage Insurance Product • SHF designed it’s MI product resembling the main characteristics of MI offered by Private Mortgage Insurers in the United States but with some necessary adaptations for the Mexican market, such as definition of claimable events, income verification for informal sector workers among other factors. • A fundamental factor when introducing MI in a market is to build credibility. This is why contracts are very clear on the fact that payment of SHF’s product is totally unconditional. • If a Government agency offers MI, prices need to be actuarially based. This is of fundamental importance because if prices are subsidized i) distortions will be introduced to the markets and ii) private sector entrance will be disincentived. SHF’s prices are actuarially based and dependant on coverage and LTV. They can be paid annually or upfront (prepaid). 13 III. SHF’s Mortgage Insurance Product • SHF’s MI provides coverage up to 35% of unpaid loan balance. It was concluded that a 100% coverage was not a good idea; partial coverage keeps lenders’ incentives to originate and service the loans properly. • We insure loans with maximum LTV’s of 90%. Recommendation is to begin with maximum LTV’s for which there’s enough data and then to gradually increase max LTV. • SHF’s MI is mandatory during the entire life of the loan. Initially this is a good idea as it promotes standardization and adequate loss mitigation efforts. • SHF’s MI claimable events are: i) foreclosure, ii) Deed-in-lieu, and iii) shortsale. Advantages are: no obligation to go through the judicial system and no need to wait until eviction to present a claim . 14 III. SHF’s Mortgage Insurance Product • Coverage is transferable. This is a necessary condition for securitization. • Every single loan is underwritten by SHF. The importance of MI lies no only on the coverage it provides but also in the fact that it assures investors, lenders and regulators that the information contained in the mortgage files is accurate. • In the underwriting process, SHF reviews each loan in order to verify if they comply with the underwriting guidelines contained in the MI contract. The following items are revised: Credit Score: Borrower must be scored using a proprietary FICO score developed by Fair Isaac for SHF. 15 III. SHF’s Mortgage Insurance Product Appraisal: The appraisal of houses must follow the appraisal rules issued by SHF and be conducted by specialized entities licensed also by SHF. Credit Bureau Check. Standard Documentation: The documentation in the loan files must follow the origination policies issued by SHF. Of special importance in this regard is the proof of income and mortgage inscription in the Public Registry of Property. 16 IV. Creating Incentives for Private Sector Entry • SHF contacted all 7 Private Mortgage Insurers that participate in the United States market in order to present them the potential of the Mexican market and the model designed to develop it. • We were looking for firms that could eventually create a permanent presence in the country. • Two firms expressed more interest in participating: United Guaranty and Genworth Financial. • We have shared all our statistical information with these companies. This is one of the most important elements that an MI firm will look when considering entry into a market. • SHF’s underwriting guidelines were also presented to the Private Mortgage Insurers and changes were made until an agreement on these guidelines was reached. 17 IV. Creating Incentives for Private Sector Entry • It was agreed that a good first step for these firms to enter the market was to subscribe reinsurance contracts with them. The advantage of this mechanism is that it allows private companies to acquire knowledge about the market before an adequate legal and regulatory framework for them to operate is put in place. • Last year SHF began reinsuring 70% of the risks its takes through its MI product with these companies. • In addition, last week a change to the Insurance Law that creates the Mortgage Insurance line of business was approved by Congress. • Secondary Regulations are now being drafted that all companies offering MI, including SHF, must observe. • Companies offering MI will be supervised by the Insurance Commission.