HOUSING FINANCE IN TRANSITION ECONOMIES

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Merilyn Sherman
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1 HOUSING FINANCE IN TRANSITION ECONOMIES OECD Workshop Warsaw, Poland December 5-6, Loïc Chiquier The World Bank 1

2 Challenge in Transition Economies! Key for growth, poverty, wealth (75 wealth), social stability (75-90% of household! Pressure from urbanization and demographics (stock( stock or flow issue?)! HF to become larger part of the financial system and contribute to its stability and profitability! Role of the state not in lending, but improving market infrastructure, regulation, targeted subsidies 2 2

Pressure from urbanization and demographics (stock( stock or flow issue?)!

3 Countries Over 50% Urban Over 50 % Reaching 50% Least Urbanized 3 3

4 Pre-Requisites to a Sizeable Housing Finance System! Macro-economic stability (inflation, real rate, EU convergence)! Workable legal framework (registered property rights, effective foreclosure, co-ownership ownership problems)! Efficient housing markets to finance (land use, urban and construction norms, taxation, RE industry professionals: developers, appraisers, realtors, brokers, etc.)! Integration within the financial system (liberalized credit sector, specialized/earmarked funds, development of fixed income securities, fitting regulatory /oversight frame) 4 4

Efficient housing markets to finance (land use, urban and construction norms, taxation, RE industry professionals: developers, appraisers,

5 Often small, instable, fragmented mortgage markets Mortgage stock < 5%-10% GDP (38% EU, 65% US) Poor access to HF services for households (if not urban professionals), delayed access to ownership, incremental or informal housing, limited impact of RE on growth Lenders / regulators perceive relative large risk exposure and difficult low profitability (vs. other credit sectors) Limited economic/cultural demand from borrowers (mortgaged home, informal income, tax avoidance) Perceived need for more subsidies (fiscally costly) but oriented competition 5 5 subsidized loans run against market-oriented competition

risk exposure and difficult low profitability (vs.

6 Poland Hun gary Housing Loans Outstanding as a Percentage of GDP 6 Denmark UK USA Germany Canada Austria Spain Chile Italy Argentina Czech Rep Source: Housing Finance International, December 2000 Percentage

7 Underdeveloped Mortgage Markets?! Slow development of mortgage securities Dominant deposit-base funding model (when very liquid banks), acceptable market risks with variable rate credits (contrast with $ 2.6 trillion MBS in the US in 1999) Yet more long-term fixed-rate funding opportunities with the diversification needs of institutional investors (notably pension funds) Complex vs. simple variants of mortgage securities (different ways to manage market risks and equity, but also different pre-requisites, requisites, objectives, costs of funds) 7 7

variable rate credits (contrast with $ 2.

8 Main Housing Finance Related Risks Credit Risk (losses due to default: capacity and will) Liquidity Risk (fear cash need) and Market Risk (impact of a change of interest rates on assets, liabilities, net interest results) Political Risk (including change of legal and regulatory system affecting the overall mortgage portfolio) Operation Risk (inadequate organization, controls, IS, corporate governance) Agent risk (misuse funds by intermediaries) for 2 nd -tier institutions (insurance, securitization, liquidity facilities) 8 8

and regulatory system affecting the overall mortgage portfolio) Operation Risk (inadequate organization, controls, IS, corporate

9 Management of Market and Liquidity Risks (I) Impact of changing interest rates on the value of assets & liabilities, and on net interest results (ex: S&L crisis) Various sub-categories: commitment risk, pipeline risk, prepayment risk, foreign exchange risk Different measure methods, hypothesis, tolerance levels More difficult context in emerging countries: volatile interest rates, no hedge derivatives, limited yield curve 9 9

risk, prepayment risk, foreign exchange risk Different measure methods, hypothesis, tolerance levels More

10 Management of Market and Liquidity Risks (II)! Adjust the credit design according to the funding structure (adjustable / discretionary rates, hard-currency loans: more credit risks)! Manage liquidity needs and cash-flows (adequate capital, funding sources, treasury department), determine ALM policy! Possible access to liquidity facility (simple, residual market risks)! Adjust duration matching, use hedging derivatives! Issue mortgage securities (securitization, mortgage bonds) although no panacea (cost of funds, preconditions)! Price residual risks through the credit (+ prepayment fees) 10 10

Manage liquidity needs and cash-flows (adequate capital, funding sources, treasury department), determine ALM policy!

11 Management of Mortgage Credit Risks (I) Residential mortgages: expected excellent risk and attractive asset (US NPL > 3 months 0.3% -3.7%) but different perception in countries where severe recent crisis (NPL > 20%: see next slide about Colombia, Mexico, Thailand, etc.) Crisis triggers (on default probability and/or loss severity): Economic crisis: unemployment, lower housing values, negative equity (disincentives to repay) Financial shock, higher rates passed to variable rate credits Unsound amortization schemes, lack of prudential lending standards and regulations Ineffective foreclosure (delays, appeals, adverse judiciary) Spreading culture of non-payment (fueled by political risk) 11 payment (fueled by political risk) 11

) Crisis triggers (on default probability and/or loss severity): Economic crisis: unemployment, lower housing values, negative equity (disincentives to repay) Financial shock, higher

12 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov % 20.0% 15.0% 10.0% 5.0% 0.0% NPL Mortgage Colombia 12 Nov-00 Sep -00 Jul-00 May-00 Jul-99 Sep-99 Nov-99 Jan-00 Mar-00 May-99 Mar-99 Jan-99 Nov-98 Sep-98 Jul-98 May-98 Mar-98 Jan-98

13 Management of Credit Risks (II) Expansion and deepening to larger-scale portfolios (including lower-income) if well-managed credit risks! Optimal credit design: risk-adjusted profitability of the lender vs. affordability of borrower, choice of interest rate and amortization scheme (including indexation)! Sound mortgage lending standards (underwriting, servicing)! Sufficient, effective and appraised mortgage collateral, and search for alternative collateral (pension, third-party, etc)! Access to reliable incomes, capacity and willing to repay, automated underwriting, credit information systems (credit history, past rental payments, relevancy of scoring models) 13 history, past rental payments, relevancy of scoring models) 13

Sound mortgage lending standards (underwriting, servicing)! Sufficient, effective and appraised mortgage collateral, and search for alternative collateral (pension, third-party, etc)!

14 Management of Credit Risks (III)! Risk adjusted pricing, modified credit policy (term, LTV)! Related insurance products! Capacity to monitor pool performance (needed for SMM)! Active debt recovery capacities (prevention, menu of restructuring/waivers/foreclosure/resale/leasing solutions)! Appropriate information of borrowers (code conduct?)! Capacity building of lending institutions (capital, expertise)! Development of partial credit insurance / guarantee schemes (risk allocation, actuarial premium, standards, moral hazard) 14 (risk allocation, actuarial premium, standards, moral hazard) 14

Active debt recovery capacities (prevention, menu of restructuring/waivers/foreclosure/resale/leasing solutions)!

15 Examples of World Bank Projects Jordan: liquidity facility issuing bonds to refinance lenders, lending standards, robust catalyst of more affordable mortgage markets Colombia: restructure distressed S&Ls industry (management of large market and credit risks, regulations, subsidies, securities) Mexico: access to bond market, separate subsidies from credit, management of risks, prudential norms, credit and MBS guarantees Latvia: pilot credit guarantees for homeowner associations, lower down-payment for homeowners, reverse mortgage loans Peru: registration /formalization of property titles ( dead assets) Algeria: assistance to lenders (training, funding, insurance), regularizing titles, enhancing mortgage rights 15 15

credit, management of risks, prudential norms, credit and MBS guarantees Latvia: pilot credit guarantees for homeowner associations, lower down-payment for homeowners, reverse

Introduction to Mortgage Insurance. Mexico City November 2003

Introduction to Mortgage Insurance Mexico City November 2003 Agenda United Guaranty Mortgage guaranty insurance Industry history Product structure and risk factors Advantages of mortgage insurance Process