S&P - Public Finance Criteria (2007). - The Global Clearinghouse

HousingPrimary or loan-specific insuranceThis can take one of three forms: conventional PMIprovided by rated mortgage insurers; guaranteesfrom the Federal Housing Administration (FHA) orthe Veteran’s Administration (VA); or USDA RuralDevelopment (RD) insurance. PMI pays claims as apercentage of loan amount. PMI coverage down to72% LTV on all loans greater than 80% LTV ismost common.When evaluating private mortgage insurers forloss coverage, Standard & Poor’s compares thefinancial strength ratings (FSR) of the insurers tothe current or prospective rating on the bonds.Insurers whose FSR ratings are at least as high asthe rating for the bonds are assumed to pay on allof their respective claims. Hence, the recoveryamounts are stipulated under the policy. It is possiblefor insurance providers with FSR ratings belowthe rating on the bonds to receive partial credit.Standard single-family FHA insurance covers100% of the mortgage principal, all but twomonths of accrued unpaid interest, and two-thirdsof foreclosure costs. VA loans originated on or afterMarch 1, 1988 are guaranteed as follows: homeand condominium loans of $45,000 or less areguaranteed at 50% of the loan amount; loans of$45,001 to $56,250 are guaranteed at a maximumpayment of $22,500; and loans of $56,251 to$144,000 are guaranteed at 40% of the loanamount, with a maximum guarantee of $36,000.Legislation passed in 2004 further increased guaranteesof a loan amount up to $417,000, with amaximum of 25% up to $104,250. There are nolimits on loan size so that if the loan amountexceeds the guaranteed limit, the value of the guaranteeis reduced on a percentage basis. VA loansoriginated prior to March 1, 1988 have a highercoverage in terms of the percent of the mortgage,but have lower limits of coverage in dollars.Manufactured home loans are covered at 40% ofthe loan, with a maximum guarantee of $20,000.Rural Development will pay its claim based onan appraisal after foreclosure has occurred ratherthan on the sale of the property, as in other insuranceprograms. RD will pay the lesser of any lossup to 90% of the mortgage, or an amount up to35% of the mortgage plus any additional loss equalto 85% of the remaining 65% of the mortgage.Adjustments must be made to the calculation toaccount for additional shortfalls in the RD insurance.These include additional coverage for the differencebetween the actual sales price and theappraised value, along with the cost of holding theproperty between foreclosure and sale.Loss severity. There is a level of primary insuranceat which the loss severity calculation can reachzero. However, when determining loss severity inconjunction with a deep primary insurance proposal,some loss always must be assumed on a foreclosedmortgage. This is because Standard & Poor’sassumes that worst-case situations will occur onsome of the mortgages in the pool. That is, a 100%market value decline and foreclosure costs higherthan 22% could result on a mortgaged property,and deep primary mortgage insurance would notcover the full loss.Foreclosure costs. Two components make upStandard & Poor’s assumption for FC (22% of theoutstanding loan): lost interest costs (9%) and hardcosts (13%). Lost interest costs arise as a result ofthe assumed loss of accrued interest for a period ofat least 12 months and are therefore equal to themortgage rate times the loan balance. The hard costcomponent includes brokerage fees (5%), legal fees(3%), taxes (3%), and other costs (2%).Agency credit. The credit portion of the loss coveragemay not be necessary for a given bond issue ifthe following conditions are met: (1) the issuer is anHFA that has an Issuer Credit Rating (ICR) or hasbeen designated “top-tier” (see state agency section);and (2) Standard & Poor’s calculation oftotal loss coverage is less than 2%. These amountsmust then be factored into the agency’s capital adequacy.In addition, when calculating the necessaryloss coverage for issues in which Standard & Poor’shas given the agency portfolio oversight and administrationcredit (but not necessarily an ICR or toptierstatus), Standard & Poor’s may find itappropriate to assume foreclosure costs lower than22%, provided that reduced foreclosure costs canbe adequately represented by the HFA over a significantperiod of time. This occurs because many ofthe variable costs associated with a foreclosurealready are included in the agency’s fixed administrationbudget, and well-managed agencies can controland reduce these costs substantially.Liquidity loss coverage. Liquidity coverage is necessarybecause of the loss of mortgage loan paymentsduring the delinquency period prior toforeclosure. Loss mitigation procedures and otherfactors can extend the length of time between delinquenciesto foreclosure to six to 24 months. Forthis reason, Standard & Poor’s assumes that liquidityshortfalls will occur for a period of approximately18 months. The liquidity coverage necessary isequal to FF divided by three years multiplied by themonthly mortgage constant times 18 months. Themonthly constant represents the level monthly principaland interest payment divided by the originalmortgage balance. The resultant liquidity coverageshould be covered by liquid reserves, for example,pledged funds in an investment agreement or aLOC, in each case from a provider with a creditrating at least as high as that assigned to the bonds.232 Standard & Poor’s Public Finance Criteria 2007