Primary or loan-specific insurance
This can take one of three forms: conventional PMI
provided by rated mortgage insurers; guarantees
from the Federal Housing Administration (FHA) or
the Veteran’s Administration (VA); or USDA Rural
Development (RD) insurance. PMI pays claims as a
percentage of loan amount. PMI coverage down to
72% LTV on all loans greater than 80% LTV is
most common.
When evaluating private mortgage insurers for
loss coverage, Standard & Poor’s compares the
financial strength ratings (FSR) of the insurers to
the current or prospective rating on the bonds.
Insurers whose FSR ratings are at least as high as
the rating for the bonds are assumed to pay on all
of their respective claims. Hence, the recovery
amounts are stipulated under the policy. It is possi-
ble for insurance providers with FSR ratings below
the rating on the bonds to receive partial credit.
Standard single-family FHA insurance covers
100% of the mortgage principal, all but two
months of accrued unpaid interest, and two-thirds
of foreclosure costs. VA loans originated on or after
March 1, 1988 are guaranteed as follows: home
and condominium loans of $45,000 or less are
guaranteed at 50% of the loan amount; loans of
$45,001 to $56,250 are guaranteed at a maximum
payment of $22,500; and loans of $56,251 to
$144,000 are guaranteed at 40% of the loan
amount, with a maximum guarantee of $36,000.
Legislation passed in 2004 further increased guar-
antees of a loan amount up to $417,000, with a
maximum of 25% up to $104,250. There are no
limits on loan size so that if the loan amount
exceeds the guaranteed limit, the value of the guar-
antee is reduced on a percentage basis. VA loans
originated prior to March 1, 1988 have a higher
coverage in terms of the percent of the mortgage,
but have lower limits of coverage in dollars.
Manufactured home loans are covered at 40% of
the loan, with a maximum guarantee of $20,000.
Rural Development will pay its claim based on
an appraisal after foreclosure has occurred rather
than on the sale of the property, as in other insur-
ance programs. RD will pay the lesser of any loss
up to 90% of the mortgage, or an amount up to
35% of the mortgage plus any additional loss equal
to 85% of the remaining 65% of the mortgage.
Adjustments must be made to the calculation to
account for additional shortfalls in the RD insur-
ance. These include additional coverage for the dif-
ference between the actual sales price and the
appraised value, along with the cost of holding the
property between foreclosure and sale.
Loss severity. There is a level of primary insur-
ance at which the loss severity calculation can reach
zero. However, when determining loss severity inconjunction with a deep primary insurance propos-
al, some loss always must be assumed on a fore-
closed mortgage. This is because Standard & Poor’s
assumes that worst-case situations will occur on
some of the mortgages in the pool. That is, a 100%
market value decline and foreclosure costs higher
than 22% could result on a mortgaged property,
and deep primary mortgage insurance would not
cover the full loss.
Foreclosure costs. Two components make up
Standard & Poor’s assumption for FC (22% of the
outstanding loan): lost interest costs (9%) and hard
costs (13%). Lost interest costs arise as a result of
the assumed loss of accrued interest for a period of
at least 12 months and are therefore equal to the
mortgage rate times the loan balance. The hard cost
component includes brokerage fees (5%), legal fees
(3%), taxes (3%), and other costs (2%).
Agency credit. The credit portion of the loss cov-
erage may not be necessary for a given bond issue if
the following conditions are met: (1) the issuer is an
HFA that has an Issuer Credit Rating (ICR) or has
been designated “top-tier” (see state agency sec-
tion); and (2) Standard & Poor’s calculation of
total loss coverage is less than 2%. These amounts
must then be factored into the agency’s capital ade-
quacy. In addition, when calculating the necessary
loss coverage for issues in which Standard & Poor’s
has given the agency portfolio oversight and admin-
istration credit (but not necessarily an ICR or top-
tier status), Standard & Poor’s may find it
appropriate to assume foreclosure costs lower than
22%, provided that reduced foreclosure costs can
be adequately represented by the HFA over a signif-
icant period of time. This occurs because many of
the variable costs associated with a foreclosure
already are included in the agency’s fixed adminis-
tration budget, and well-managed agencies can con-
trol and reduce these costs substantially.
Liquidity loss coverage. Liquidity coverage is nec-
essary because of the loss of mortgage loan pay-
ments during the delinquency period prior to
foreclosure. Loss mitigation procedures and other
factors can extend the length of time between delin-
quencies to foreclosure to six to 24 months. For
this reason, Standard & Poor’s assumes that liquidi-
ty shortfalls will occur for a period of approximate-
ly 18 months. The liquidity coverage necessary is
equal to FF divided by three years multiplied by the
monthly mortgage constant times 18 months. The
monthly constant represents the level monthly prin-
cipal and interest payment divided by the original
mortgage balance. The resultant liquidity coverage
should be covered by liquid reserves, for example,
pledged funds in an investment agreement or a
LOC, in each case from a provider with a credit
rating at least as high as that assigned to the bonds.Housing232 Standard & Poor’s Public Finance Criteria 2007