The Role of the National Housing Mortgage Finance Corporation

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  • Strengthening mortgage-backed securitizationin the Philippines: The role of the National HousingMortgage Finance Corporation (NHMFC)

    Daisy S. Dulay and Marife M. Ballesteros

    Philippine Institutefor Development StudiesSurian sa mga Pag-aaralPangkaunlaran ng Pilipinas No. 2013-20 (December 2013)ISSN 1656-5266

    PIDS Policy Notes are observations/analyses written by PIDS researchers on certainpolicy issues. The treatise is holistic in approach and aims to provide useful inputs fordecisionmaking.

    The authors are, respectively, Vice-President for Operations and Securitization, Na-tional Home Mortgage Finance Corporation (NHMFC), and Senior Research Fellow,PIDS. This Note benefited from the comments of NHMFC President Dr. Felixberto U.Bustos. The views expressed are those of the authors and do not necessarily reflectthose of PIDS or NHMFC or any of the studys sponsors.

    Policy Notes

    ith stricter risk management for banks andfinancial institutions and the need to address thehousing gap of nearly three million units annually,strategies that will provide long-term funds andexpand home finance specifically to the low- andmoderate-income households are essential toensure the sustainability of housing finance. Onepotential option is to develop mortgage-backedsecuritization (MBS) to strengthen the privatesecurities market and the capital market. So far, thePhilippine mortgage loans-to-GDP ratio is onlyabout 10 percent, which is considered small basedon standards of existing mortgage systems. Inadvanced economies, housing mortgage depth isbetween 30 and 75 percent.

    This Policy Note discusses the role of the NationalHome Mortgage Finance Corporation (NHMFC) indeveloping securitization in the country. TheNHMFC is the major government corporationcreated to operate as a secondary mortgage

    institution but this mandate has not been fullyimplemented in the past 30 years as NHMFCoperations have been diverted to loan origination.With the approval of the Securitization Act of 2004and improvements in the financial sector,opportunities to engage in securitization haveopened up. The NHMFC has taken this opportunityto undertake securitization as a strategy to expandhome finance.

    Overview of NHMFCs historyThe NHMFC was created in 1977 by virtue ofPresidential Decree 1267 that gave it the mandateto develop and operate a secondary market forhome mortgages. This mandate was patterned afterthe United States (U.S.) Fannie Mae and FreddieMac that back then were considered the models forhome finance securitization. The NHMFC was

    W

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    operating relatively well before 1984 in performingits mandate of buying home mortgages originatedby private financial institutions and eventuallyselling them to the public as Housing ParticipationCertificates.

    However, the financial crisis that hit the country in19841986 caused interest rates to shoot up from30 to 40 percent, making it impossible for theNHMFC to operate viably because housing loaninterest rates were fixed at nine percent. By the endof 1986, NHMFC and other government-controlledhousing finance institutions were given a freshmandate under Executive Order (EO) 90. EO 90provided for an integrated home finance programfor the middle- to low-income home buyers(members of the three pension funds) through theUnified Home Lending Program (UHLP). Specifically,the NHMFC mandate was expanded to includeorigination, utilizing long-term funds from theSocial Security System (SSS), the GovernmentService Insurance System (GSIS), and the HomeDevelopment Mortgage Fund (HDMF), in additionto purchasing home mortgages originated by bothpublic and private financial institutions and privatedevelopers.

    The UHLP, however, was suspended in 1996 due tolow repayment rates and huge amount ofuncollected loans. Loan collection efficiency wasestimated at only 60 percent. Delinquent accountsfor over three months represented 63 percent oftotal accounts. This problem left the NHMFC withan outstanding debt balance of PHP 46 billionwith SSS, GSIS, and HDMF. The economic slowdown

    in 1998 created further difficulty to implement anaggressive asset recovery program. This situationforced the NHMFC to undertake a financialrehabilitation program in 2002, which included arestructuring of its debt obligations with thefunders and a disposition and liquification programof its delinquent portfolio.1 This situation alsocaused the NHMFC to redirect its operations to itsprimary mandate of secondary mortgage institution.

    The financial rehabilitation undertaken resultedin a financial turnaround. Starting 2005, theNHMFC posted a positive net income after morethan 10 years of insolvency and a negativebalance sheet. This is remarkable as it was donewithout any government bailout. It also showsthat it is possible for an insolvent organizationto do a financial turnaround through a totalportfolio management approach.

    In 2007, NHMFC laid the building blocks for itstransformation into a secondary mortgageinstitution (SMI). The organization was streamlinedfrom an 850-plantilla organization to a lean 300personnel. The training and gearing of its internalsystems and processes for secondary mortgageoperations also enabled NHMFC to issue its firstsecuritization in 2009, which was a success andtwice oversubscribed. It was awarded the BestSecuritization Deal for 2009 by the Asian AssetMagazine in January 2010 in Hong Kong. In 2012,NHMFC offered its first retail and publicly listedMBS in the country. The same issue was given theMost Innovative Award in 2012 by the PhilippineDealing Exchange in Manila.

    Framework for a good securitizationprocess2Securitization is the process of legally isolatingexisting asset pools or future-generated assets

    ______________1 This is the first bulk nonperforming loan sale in thecountry.2 This framework is courtesy of NHMFC President, FelixbertoU. Bustos, Jr. It was presented at the SHDA and CREBANational Developers Convention, September 26, 2013,Fairmont Hotel, Makati City, Philippines.

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    away from the company where thereceivables originate. Figure 1illustrates the process ofsecuritization.

    In particular, the key factors for an SMIsuch as NHMFC to function efficientlyare: (1) initial capital; (2) extractionrate; and (3) turnover rate.

    Funding or capitalization. Thisrefers to the equity capital infusionnecessary for the SMI to undertake andgrow its business. The funds will beused to meet start-up costs andoperational activities. Initialcapitalization requirement is usually substantialgiven the role of the SMI as a central refinancingplatform. The U.S. Federal Home Loan MortgageCorporation (Freddie Mac) was provided with aninitial funding of USD 100 million while HongKong Mortgage Corporation had an authorizedcapital of HKD 3.0 billion. Ideally, a liquidityfacility, such as SMI, would be a stand-aloneinstitution but its long-term future should bewith the private sector, that is, future fundingshould be raised through the market.

    Extraction rate. Extraction rate is the amountor value that has been generated from asecuritization transaction less any and alltransaction or friction costs. Generally, these arethe funds that can be readily utilized for future/subsequent securitizations. Extraction rate is notthe same as recovery rate as this fund grows overtime and ensures sustainability in housing finance.

    The extraction rate is affected by: (a) the supplyof securitizable accounts (or the asset pool); (b)the quality of the asset pool/accounts; and (c)

    the creation/availability of investors, particularlythe development of a professional market forsubordinate tranches.

    Leverage. This is the ability of the SMI to useits securitized instruments or its operations as asupport mechanism for financial capital to ensurecontinuous liquidity in the market (for theinvesting public). This necessitates the existenceor development of the following: (a) faster duediligence processes (which include the presenceof standardized and simplified forms for borrowers,originators, and lending institutions alike) and(b) streamlined review and due diligenceprocesses for the lending institutions. Theaforementioned measures would ensure thequality of the assets/mortgages originated andincluded in the asset pool for securitization.Other processes that are essential include thesharing of credit files, and standardization andsharing of valuation parameters/standards and data.

    Aside from these factors, securitization wouldneed a partnering arrangement whereby the SMI

    Figure 1. The securitization process

    Source: Limlingan (2000) in Bustos (2013)

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    provides for a risk-sharing approach with banksand other institutions in all the securitizationactivities going on. This implies that any and allissuances should be rated investment-grade andof low risk but with a stable yield.

    NHMFC securitization experienceBetween 2009 and 2012, NHMFC has undertakentwo securitization issuances called Bahay Bonds1 (BB1) and Bahay Bonds 2 (BB2). BB1represents NHMFCs first securitization issue. Thisissue is valued at PHP 2.06 billion backed bymore than 12,000 prime residential mortgageloans, which are the best quality loans inNHMFCs portfolio (Table 1). These loans have notbeen restructured and loan payments wereconsistently up to date with a collectionefficiency rate at the time of issue of about 98

    percent. BB1 was offered only to institutionalinvestors (mainly banks).

    BB2 was issued in 2010. The bonds are valued atabout PHP 604 million backed by more than 4,000current and restructured NHMFC UHLP accounts.Unlike BB1, BB2 was offered to the general public.This was the first retail asset-backed security or ABS(denominated at PHP 5,000) offered and listed a

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