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Published by the CIPS Network of the National Association of REALTORS®
First Quarter 2002
Development from Inside Out
By Gilles E. Girard, CIPS, FRI
A Canadian Mortgage Loan Program provides a public-private partnership modelfor private housing and construction industries in countries in transition.
Introduction
Housing a country's population is an extremely difficult, yet extremely important function, impacting the quality of life of every citizen. Adequate housing is the cornerstone of a well-developed social order. Security of the person, social stability, better health and crime reduction are all proven to result from better housing, and are very good reasons to strive for housing excellence. The housing objective for countries in transition is discussed regularly. International and foreign institutions have written many reports. Many countries in transition would like to pursue such an objective, but the political and institutional process to reach the goal is complex and challenging.
Offered below are some insights from my personal experience in helping countries in transition to develop the field of housing finance. I have identified the most fundamental factors that must be present in order to realize an effective housing finance program, and some key issues inherent in the establishment of a new housing finance system in transition countries. Most important among those issues is the need for a well-organized government agency mandated to take the lead on the coordination of various groups to agree upon and achieve the desired goal. Simply put, without such a government-directed program, there can be no residential real estate development market.
Housing Issues
The private housing and construction industry in transition countries has not historically been very strong. Today, major constraints to the accessibility of decent dwellings exist, due both to the lack of private enterprise and the lack of budgetary funds to meet the needs. In my meetings with senior officials and business representatives, there have been four major issues of common concern to transition economies: availability of affordable loans, cost of housing, problems with enforceability of the mortgage contract in the event of default, and the need for a consistent policy for the development of housing and mortgages.
In most developing economies there is no housing credit system as exists in Western Europe, North America or Australia. Loans are generally short term, the equity requirement is high and interest rates are high and variable. In many cases, houses are financed on installment contracts with the developers. In fact, people may prefer this method, since they may not want to obligate themselves to a long-term mortgage when their economic future is uncertain. The combination of low wages and high costs of financing (down payment and interest) make it very difficult for most citizens to afford a home.
Construction costs are high due to the use of old technology and materials to build housing units. Builders have not modified their construction methods to increase their productivity and gain efficiency in the past decades. Other costs include excessive taxes and land transfer fees. Banks and financial institutions have also discussed those concerns, along with the question of legal enforcement of mortgages, in great detail.
The issue that has received less attention is the general lack of consistent direction, cooperation and follow-up with government housing policy. All participants in the housing industry, including all levels of government, financial institutions, promoters and builders of housing units, must work toward a shared vision. Each one must define its goals to reach this vision and must be held accountable. In Canada, for instance, this responsibility rests with both the public and the private sectors. This public and private partnership is a result of the cooperation of a multitude of stakeholders all with a common purpose of providing their citizens and clients with the best housing of the entire world. This partnership did not just appear on its own; it was consciously created, nurtured and has continuously evolved as the needs of the marketplace have changed.
The Canadian Mortgage Loan Guarantee Program
One way for the government to support affordable housing development is to provide credit risk insurance to the private sector lenders, in order to entice them into under-served markets. The Canadian Loan Guarantee Program is a national program delivered through a network of approved financial institutions. It provides increased access to housing by guaranteeing high ratio mortgage loan for homeowner in Canada. Here are some of its key features:
· The premium structure is geographically invariant for borrowers who meet minimum acceptable terms and conditions of the Program.
· Within the Guarantee Fund, cross-subsidization of risks is available from low risk geographic areas and low risk borrowers to higher risk areas and borrowers.
· The premium increases with loan to value ratio since it is the known key determinant of risk of default.
· The one-time up front premium payment covers approved financial institutions against risk of borrower default for the full amortization period of the mortgage loan.
· To further assist in accessing homeownership, the one-time premium may be capitalized in the mortgage loan amount.
· The guarantee or insurance policy covers 100% of the balance of the mortgage loan and the interest for a determined period with approved financial institution other costs against losses.
· Both the lender and the guarantor can foreclose on the security as well as pursue borrower covenant to cover part of or all losses incurred in the event of borrower default.
The Mortgage Guarantee Fund is operating on a commercial basis and is managed prudently on an actuarial basis to break even over the long term. The Government of Canada is paid a reinsurance premium for the guarantee it provides to the Mortgage Guarantee Fund should the Fund find itself in financial difficulties and become financially insolvable. No call on this government financial backing has ever been done by the Mortgage Guarantee Fund. However, the success of the Fund rests on the solid foundation of a strong market infrastructure.
To adapt the Canadian guarantee model to a specific market, a good understanding of the entire environment affecting the efficient working conditions of a mortgage loan guarantee system is needed. Certain key characteristics must be assessed in order to develop and implement a strategic plan for a mortgage loan guarantee.
1. A sustained minimum market demand must be seen in the future.
This housing market demand will exist when there is a consumer commitment to home ownership and its responsibilities, and when there is an unmet demand or a continued growth in demand for home ownership. Potential clients must also have stable incomes sufficient to afford modest housing units and have the availability of mortgage loan financing from financial institutions. But the most important point is the government support for accessibility to affordable housing for its citizens.
For planning purposes, statistics about the housing stock situation and about the level of income of its citizens, as well as data about overcrowding, housing quality, age of housing units, housing infrastructure, construction permits, rural and urban housing stocks are necessary. In some cases, there is information available, but not in the right format for the kind of analysis that is required to fully appreciate the housing market risk and performance. Similarly one must be very careful in reviewing and assessing any data, and attempt to verify against other sources. For example, in transition countries, historical data collections were done for centrally planned government operations not for market-oriented operations, which can affect their reliability.
2. A supportive environment for economic and institutional policies must be present in all levels of government. Local social pressures from international development institutions around the world as well as those from government in countries in transition force action into the housing field, in particular the housing financial aspect. Some governments are taking actions to solve their housing issues. Government now allocated and prioritized their limited amount of funding available. Some countries in transition have for all intend purposed no funding flexibility what so ever. In some instances they never add any. Since home ownership and related activities have been modified by many government decrees in the past 40 years under previous government regime, today governments feels they must rewrite mortgage law to give better credibility.
Once a decision is made on housing policy by a government, it should be consistently supportive of the direction taken. The overriding policy objective has to be clearly communicated to all stakeholders, but expectations have to be managed so that measurement of results and progress is realistic. Any new institution created to assist in the implementation of these housing policies should be mandated to coordinate its concerted efforts amongst all others. A leadership and coordination role of all housing efforts should be well established and all institutions related to housing activities held accountable for actions taken and result.
It is preferable in my view for economic policies to encourage private sector involvement in the provision of housing for all residents, including low-income population. Its focus for economic housing policies is to support diversification of the housing industry as a whole rather so that it can be sustained without direct government expenditure for housing development or lending.
Construction and rehabilitation financing is important. In most developing countries, the primary need is for new housing construction and financing. In the transition economies, there is a greater need for financing the purchase of existing units as well as much-needed repair and rehabilitation. Construction loans are not generally available through financial institutions, nor are they desired by developers, due to the interest costs and added requirements of the banks. However, construction financing allows the development and delivery of more units, which lowers the incremental cost of construction. A properly constructed guarantee system could also facilitate the availability of this type of financing, and at the same time encourage the growth of more efficient home construction businesses. And, it can increase the availability of financing for home improvements. All of this activity will inspire growth of the secondary market for home sales, which improves the overall risk in the system for lenders and owners alike.
3. Mortgage loan financing and products must be affordable.
Since 1989, wage growth has been modest at best in most transition countries and incomes have not kept up with inflation. This means that at least two incomes will be required for most households to afford a new housing unit. Low or no wage growth and high inflation in recent years have also reduced savings. Some limited mortgage financing is available through private, foreign sources, but primarily from specialized state banks. The source of funding for the state banks is primarily citizen deposits guaranteed by the government. Mortgages are generally short term, high rate, variable rate and payment, with minimum of 30% down payment (plus transaction costs). Due to high inflation, to local currency on-going devaluation and to client potential risks, the mortgage loan rate fluctuates greatly. There are other important issues that constrain access to homeownership. Limited serviced land is available for new housing constructions from municipalities. Setting up and developing the domestic residential infrastructure is an issue. The procedure of getting a residential construction permit is long and expensive. Approval of new technology and material standards by government agencies and laboratories are very expensive and take a very long time. All of these problems limit further access to homeownership but ultimately affordable mortgage financing appears to be the key issue.
4. Management capacity of financial institutions to administer and to deliver a mortgage loan program, inclusive of a mortgage loan guarantee system, must be adequate. Currently, lenders obey very strict underwriting guidelines, target only the upper income markets and have been successful in avoiding losses in the past ten years. There is basically no risk to the financial institutions and very little activity in housing finance. Due to this lack of experience bank lenders are likely to be less skilled in dealing with borrowers at the margin, and in identifying risk-mitigating actions. There is a need for additional training in risk assessment for financial institution members who will be delivering mortgage credit to low and moderate-income buyers, especially under the requirements of a mortgage guarantee system. Since a mortgage loan guarantee program protects mortgage lenders from loss, there is less incentive for them to be prudent in underwriting, hence well-documented policies and procedures and an excellent operational audit program is necessary.
Financial institutions also have limited knowledge and experience in servicing mortgage loans. In most cases, the ultimate risks of mortgage lending (especially medium to long term lending) are unknown since high delinquencies have been attributed to a lack of attention in servicing the real estate portfolio or catastrophic economic shocks. I have found that training in underwriting must also be accompanied by training in servicing techniques and loss mitigation strategies, particularly where the ability to foreclose the property and evict tenants is still limited.
Most first time buyers and loan customers are not versed in the requirements and responsibilities of homeownership or of a mortgage (this is true everywhere). Therefore, credit officers should also receive training in consumer education. Consumer education, prior to making the decision to purchase a home and to agreeing to a mortgage loan commitment, will become more critical for financial institutions in serving lower income clients with little or no savings. Financial institutions will have to rely on such options as individual counseling, video presentation, first-time-buyer seminars and marketing material to deliver its services.
Finally, in most countries in transition there has been no formal professional training for mortgage loan underwriters, residential inspectors and appraisers. Similarly the housing market analyst function does not exist and must be developed. These professions have to be created and be formalized in order to have a strong sustainable housing industry.
Conclusion
In conclusion, I believe that a strategic implementation of a mortgage loan guarantee program would provide access to mortgage financing for greater opportunities to homeownership and would greatly assist in developing a housing market in countries in transition. Planning and implementing such national mortgage loan guarantee program would greatly assist the local lending institutions to move quickly into residential lending operations to facilitate accessibility to home ownership. Government support has been key to improved housing conditions of developed countries, and it is also true for developing markets.
Initially a government-sponsored agency is needed and must be mandated by the government to take the lead role in all aspects related to the housing industry, in particular housing finance. Appropriate processes and procedures must be developed to deliver the housing program in participation with interested organizations. A liquid and solvable mortgage loan guarantee fund must be instituted. Financial institutions must be trained in the mortgage loan initiation process and in mortgage servicing activities for not only guaranteed mortgage loans but also for conventional mortgage loans. A major consumer education program must be undertaken to explain to its citizens how they can access and afford a home with the new program.
Gilles E. Girard CIPS, FRI, M.P.A., B.Sc. is a partner and senior consultant with Gilles E. Girard Consultants Inc. in Orleans, Ontario, Canada. He works with senior executives to accomplish major shifts in organizational mission and direction. He also interprets and implements Canadian housing technology, services and products abroad, with particular emphasis on housing finance. He has held senior executive positions with department of Consumer and Corporate affairs Canada and the Canada Mortgage and Housing Corporation (CMHC), serving on its board for 6 years. An expert in change management, he specializes in strategic planning, process re-engineering, organization development, organization and methods. He is fluently bilingual in French and English. He can be reached at gillesegirard@cyberus.ca. |
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