Relevance of mortgage guarantee in India s housing finance market and Corporate profile of India Mortgage Guarantee Corporation Private Limited

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1 Contents may be used freely with due acknowledgement to ICRA. This report has been prepared by ICRA covering the relevance of mortgage guarantee in India s housing finance market and corporate profile of India Mortgage Guarantee Corporation Private Limited (IMGC). All information contained herein has been obtained by ICRA from IMGC and from sources believed by it to be accurate and reliable. Although reasonable care has been taken to ensure that the information herein is true, such information is provided 'as is' without any warranty of any kind in particular, neither ICRA nor its agents make any representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information or communication. ICRA or any of its group companies, while publishing or otherwise disseminating other reports may have presented data, analysis and/or opinions that may be inconsistent with the data, analysis and/or opinions presented in this publication. All information contained herein must be construed solely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of this publication or its contents. Further, no aspect or conclusion of this report is meant to be construed as advice ICRA is not: (a) providing an audit opinion or any financial, legal, tax, advisory, consultative or business services; or (b) advising on structuring, drafting or negotiating transaction documentation. Independent legal, tax, financial and other advice must be taken when structuring, negotiating and documenting transactions. Any discussion with ICRA s analysts does not constitute advice on business operations. The assessment exercise of the entity concerned has been done for the limited purpose for which it has been intended and not for any other purpose. ICRA s opinions expressed in this report are not an indication of any prospective rating/grading of the entity concerned and/or any instruments to be issued by such entity. Further, anything contained in this report should not be construed as a recommendation of any kind including to deal with the entity concerned and/or buy, sell or deal in securities/instruments issued/to be issued by such entity. Relevance of mortgage guarantee in India s housing finance market and Corporate profile of India Mortgage Guarantee Corporation Private Limited ICRA LIMITED CORPORATE OFFICE Building No. 8, 2nd Floor, Tower A, DLF Cyber City, Phase II, Gurgaon Tel: Fax: info@icraindia.com, REGISTERED OFFICE 1105, Kailash Building, 11th Floor, 26 Kasturba Gandhi Marg, New Delhi Tel: Fax: Branches: Mumbai: Tel.: + (91 22) /53/62/74/86/87, Fax: + (91 22) , Chennai: Tel + (91 44) /9659/8080, / 3293/3294, Fax + (91 44) , Kolkata: Tel + (91 33) / / / , Fax + (91 33) , Bangalore: Tel + (91 80) /4049 Fax + (91 80) , Ahmedabad: Tel + (91 79) /5049/2008, Fax + (91 79) , Hyderabad: Tel +(91 40) /7251, Fax + (91 40) , Pune: Tel + (91 20) /95/96, Fax + (91 20) Copyright, 2015, ICRA Limited. All Rights Reserved. December 2015

2 Contents 1. Executive Summary Overview of India s mortgage market Robust housing credit growth to push-up mortgage penetration Increase in prominence of HFCs in the housing loan market Stable operating environment and asset quality for the mortgage finance industry Introduction to the mortgage guarantee About the MG product Key benefits of Mortgage Guarantee Lower Capital requirements Lowering of credit enhancements on securitization transactions Impact on Return on net worth Impact on the ROE for Securitisation transactions Improves lender product offering Improves lender cash flows Improves risk management for lenders Impact on mortgage penetration and customer behavior Introduction to India Mortgage Guarantee Corporation Private Limited ICRA s credit rating on IMGC IMGCs business profile Strong support from shareholders IMGC in early stage of its roll-out Processes followed by IMGC...22 Annexure 1: Trends in property prices...23 Annexure 2: Capital relief computation...24 Annexure 3: Key Regulations for Mortgage Guarantee Companies (MGC)...25 Executive Summary India s Rs trillion housing credit market has expanded at a healthy 3 year CAGR of 19% and by 18% in FY15 on the back of a sustained rise in housing demand. India s mortgage finance penetration is low at 8.41% as on March 31, 2015 vis-à-vis developed countries, which along with the favorable demographics, significant affordable housing requirements and Government of India s Housing for All mission, and likely rise in new housing project launches, is expected to push up housing credit growth to 20-22% over the medium to long term. Indian mortgage lenders in order to effectively tap the opportunities offered by the mortgage market would require capital or seek risk transfer options. The mortgage market however is funded primarily by traditional products, given that funding by the secondary mortgage market is insignificant. Further, there are limited economical options available for credit risk transfer a situation that forces originators (or lenders) to rely on equity as the sole source of core Tier I capital to meet their economic capital requirements. Such reliance on equity could hamper lenders growth prospects or lead to overleveraging when capital market conditions are not conducive. Access to external equity could also remain limited for long periods if investors are hesitant or promoters unwilling to dilute at low valuations. Mortgage guarantee (MG), a relatively new product in India, is actively used by lenders in developed markets as a tool to manage credit risks on home loan contracts. A lender can take MG protection on a home loan or a pool of home loans from a Mortgage Guarantee Company (MGC) to partly protect itself against credit losses in the event of a default by the borrower. The lender has the ability to invoke the MG as soon as the contract becomes a Non Performing Asset (NPA) as per the RBI norms. As India s mortgage finance market expands, presence of a MG could help lenders: Find an alternative source of capital: MG is recognised as a valid Credit Risk Mitigant for capital adequacy computation purposes. This means that from a lender and regulatory perspective, there is an element of risk transfer from the lenders ecosystem to the balance sheet of the MGC, which allows the lender to release capital. Better capital efficiency offered by a MG could help lenders leverage the potential of India s mortgage finance market. Furthermore more efficient use of capital provided by a MG could enhance Return on Equity (ROE) for shareholders. Based on ICRAs estimate HFCs would need to mobilize external equity Rs billion (30-50% of their present Net worth) over the next five years to grow while maintaining the capitalisation levels at their current level. MG could help mortgage lenders maintain prudent capitalisation levels even in unfavourable market conditions, without having their growth prospects curtailed or compromising on shareholder returns. Manage credit risks and enhance access to new customer segments: MG allows lenders to mitigate credit risks, which could arise over the long cycle of a mortgage due to economic cycles or a decline in housing prices. Further credit protection available to mortgage lenders through MG could also help lenders to enhance their product offering and better tap the opportunities present in new and emerging customer segments. 1 As in March 31, Housing credit as % of GDP 3 Depending on the type and level of loss share opted for, subject to loan meeting conditions specified by the MGC 02 03

3 Overview of India s mortgage market India Mortgage Guarantee Corporation Private Limited (IMGC) is India s first mortgage guarantee company IMGC is setup as a joint venture between National Housing Bank, Genworth Financial Mauritius Holdings, International Finance Corporation and Asian Development Bank. IMGC is rated by ICRA at IrAA (pronounced Issuer Rating double A) with a Stable outlook. This is the high-credit-quality rating assigned by ICRA. The rated entity carries low credit risk. The rating is only an opinion on the general creditworthiness of the rated entity and not specific to any particular debt instrument. The outlook of the rating is Stable Robust housing credit growth to push-up mortgage penetration Figure 1: Growth trend in Housing Credit in India Figure 2: Housing Credit as a % of GDP Please refer to section 4.1 for ICRAs rating rationale Source: RBI, Financial results and Analyst Presentations of mortgage lenders, and ICRA s estimates India s Rs trillion housing credit market has expanded at a healthy 3 year CAGR of 19% and by 18% in FY15. ICRA expects the housing credit market to maintain a favourable growth over the medium term buoyed by the following factors: India s vast and under-penetrated market (Housing Credit as a % of Gross Domestic Product (GDP) remains low at around 8.41% as at March 31, 2015) resulting in large growth potential Favorable demographics given the young population, increasing trend of nuclear families, rapid urbanisation and rising middle income segment with growing disposable income Easy availability of credit especially in metros and tier 1 cities and potential softening of interest rates over the next few years Government of India Housing for All mission is expected to augment the housing supply and provide borrowers in the affordable housing segment incentives for availing housing credit Increase in new project launches and improvement in the pace of under-construction projects as the operating environment improves In ICRAs opinion over the medium and long term, the housing credit growth could be 20-22% supported by focus of the government on Housing for All by 2022, which could push the mortgage penetration levels to over 15% by March 2020, which is around 5% higher than what could be achieved otherwise. 4 As in March 31,

4 2.2. Increase in prominence of HFCs in the housing loan market Banks are the largest housing credit lenders in India and account for ~63% of the market as on March 31, However their market share has declined from 70% in March 2010 as Housing Finance Companies (HFCs) have gained share on the strength of their focussed approach, comparatively superior service levels, and presence in relatively high growth segments like affordable housing, self employed customers etc. Against a 3-year CAGR of 25% reported by HFCs, housing credit growth for banks was lower at 18%. Bank credit growth however has increased from 15% during the preceding 3 year period (FY10-FY13) given the increase in focus to grow in segments with better capital efficiency and with relatively lower credit risk.. ICRA however expects HFC s to continue to grow at a faster pace vis-a-vis banks given their strengths discussed earlier. While HFCs cater to prime salaried, self employed and low income segments, they face stiff competition from banks in the prime salaried home loan segment. As a result smaller HFCs target niche segments such as self employed borrowers or affordable housing customers to optimise their yields and capitalize on higher growth potential. In addition to the borrower profile, the product mix is the other key determinant of the riskiness associated with the HFCs. Figure 4: Various Borrower Segments catered to by HFCs Source: ICRA s Analysis 5 FY13 to Fy15 Figure 5: Risk spectrum for the products offered by HFCs Figure 3: Key players in the housing finance market Source: RBI, Financial results and Analyst Presentations of mortgage lenders, and ICRA s estimates 2.3. Stable operating environment and asset quality for the mortgage finance industry India s mortgage credit market has witnessed a relatively stable operating environment on the back of healthy credit growth, relatively stable property prices and stable asset quality indicators. Figure 6: Quarterly Trend in Gross NPA Percentage of HFCs Source: HFCs and ICRA s analysis Figure 7: Quarterly Trend in Net NPA Percentage of HFCs HFCs have been able to maintain a control over asset quality with a Gross NPA% of 0.70% as on March 31, While inventory pile-up has increased in some metros resulting in some correction in prices, nevertheless, so far there has not been any significant deterioration in asset quality in these regions. In ICRA s view the expected improvement in economic environment with the softening of interest rates and improving borrower income would support housing prices and the overall industry s prospects. Please refer to annexure 1 for the trend the NHB published property price index Residex ICRA notes the increased focus of some of the players on products (such as LAP and builder loans) and/or change in their borrower profile towards the self-employed and low-income segment, where income streams could be more volatile. Such a change could increase the riskiness associated with HFCs loan book and could lead to an increase in gross NPA%. Nevertheless, the strong monitoring and control processes, borrowers own equity in the property and the large proportion of borrowers staying in self-occupied property could reduce the impact of the above mentioned concerns on asset quality to an extent. Overall the Gross NPA% expected to remain range-bound at 0.7% - 1.1% over the medium term. Table 1: Key portfolio parameters of HFCs Parameter Average Ticket Size Housing (in Rs. million) 2.1 % of Salaried Segment Portfolio 79% Portfolio at Fixed Obligation to Income Ratio (FOIR > 50 %) 16% % of floating rate loans 72% % of portfolio at more than 80% Loan To Value Ratio (LTV) 13% Prepayment / Foreclosures as % of Portfolio 11% Source: HFCs and ICRA s analysis Close to 80% of HFCs home loans are to salaried customers who have relatively predictable cash flows. Further, good underwriting standards as reflected in limited proportion of portfolio at higher FOIR or higher LTVs also help the lenders in maintaining good asset quality. The interest rate structure too indicates a favorable outlook on the asset quality of HFCs. Floating rate loans constitute a significant 72% of the asset book. Thus if interest rates were to decline, the debt-servicing burden (EMI in relation to income) could ease, or the pace of equity buildup (in the property financed) could rise, leading to a favorable credit profile. 6 Housing loans attract a 35-75% risk weight depending upon the Loan to Value (LTV) ratio and ticket size of the loan 7 Depending on the type and level of loss share opted for, subject to loan meeting conditions specified by the MGC 06 07

5 Table 2: Top Cover Product Mortgage Guarantee (MG), a relatively new product in India, is actively used by lenders in developed markets as a tool to manage credit risks on home loan contracts. A lender can take MG protection on a home loan or a pool of home loans from a Mortgage Guarantee Company (MGC) to partly protect itself against credit losses in the event of a default by the borrower. The lender has the ability to invoke the MG as soon as the contract becomes a Non Performing Asset (NPA) as per the RBI norms. As India s mortgage finance market expands, presence of a MG could help lenders Manage credit risks and enhance access to new customer segments: A MG allows lenders to mitigate credit risks, which could arise over the long cycle of a mortgage due to economic cycles or a decline in housing prices. Further credit protection available to mortgage lenders through MG could also help lenders to enhance their product offering and better tap the opportunities present in new and emerging customer segments. Achieve capital relief: MG is recognised as a valid Credit Risk Mitigant for capital adequacy computation purposes. This means that from a lender and regulatory perspective, there is an element of risk transfer from the lenders ecosystem to the balance sheet of the MGC, which allows the lender to release capital. Better capital efficiency offered by a MG could help lenders leverage the potential of India s mortgage finance market. Based on ICRAs estimate HFCs would need to mobilize external equity Rs billion (30-50% of their present Net worth) over the next five years to grow while maintaining the capitalisation levels at current levels. Part of this capital could be tapped in the form of a MG About the MG product Introduction to the mortgage guarantee Lenders can take a MG on the following type of home loan contracts: Flow: The guarantee cover taken by the lender on new housing loans i.e. at the time of origination Seasoned Flow / Bulk: The guarantee cover taken by a lender on existing contracts i.e. loans which are seasoned Securitization: The guarantee taken by originators as a credit enhancement on securitization transactions The MG would cover the principal and interest outstanding on the loan, up to the amount of the guarantee. Lenders can seek a MG against payment of a fixed premium determined at the time of taking the cover. A MGC would typically carry out its own assessment of the lender and apply contract level selection criterion to determine the premium. Premiums are either paid by the lender or the customer. While a MG can be structured based on a lenders requirement, it typically takes two main forms Top Cover: Under this product, a MGC bears the first loss on a contract. The MGCs liability is capped to the extent of MG coverage (for example, 20%), expressed as a percentage of the loan amount outstanding at the time the contract becomes an NPA on the books of the Lender. Losses in excess of the first loss covered by the MG, if any, are borne by the Lender, as is illustrated in the table below. MG cover taken 10% 20% 30% Loss at contract level upon 15% 25% 15% 25% 15% 25% settlement or foreclosure Loss borne by the Lender 5% 15% 0% 5% 0% 0% Loss borne by the MGC 10% 10% 15% 20% 15% 25% Source: ICRA Research Quota Share: Under this product, loss at a contract level is shared on a pro-rata basis between the lender and the MGC. As in the case of the top cover product the maximum liability borne by the MGC is capped to the extent of the MG coverage (for example, 20%), expressed as a percentage of the loan amount outstanding at the time the contract becomes an NPA on the books of the lender. Any loss incurred at a contract level would be shared between the lender and the MGC on a pro-rata basis (based on the agreed split between the two parties involved), as is illustrated in the table below. Table 3: Quota Share Product MG cover taken 10% 20% 30% Loss at contract level 15% 25% 50% 15% 25% 50% 15% 25% 50% Loss borne by the Lender 14% 23% 45% 12% 20% 40% 11% 18% 35% Loss borne by the MGC 2% 3% 5% 3% 5% 10% 5% 8% 15% Source: ICRA Research In the quota share product since the loss is split pari-passu between the lender and the MGC, there is an alignment of interests between the lender and MGC. The extent of credit risk retained by the Lender after taking MG cover on its portfolio depends on the nature of the MG product and the extent of MG cover available from the MGC. Ÿ With both product options the loss incurred by the Lender decreases with an increase in the MG cover available from the MGC. For example, under the Quota Share product, if loss at contract level is 25%, loss borne by the Lender is 23% with 10% loss cover and 18% with 30% loss cover. Ÿ Similarly, the Lender benefits more (i.e. incurs lower loss) under the Top Cover product as opposed to the Quota Share product. For example, if the loss at a contract level is 25% and extent of loss cover available from the guarantor is 30%, the loss borne by the Lender is 18% under the Quota Share product, and NIL under Top Cover product. It must be highlighted here that the above examples do not take into account the interest shortfall that would be met by the MGC (only principal shortfall is factored into the above illustration). The actual loss that would be booked by the Lender may vary slightly depending on the timing of the loan turning into a NPA and the accounting policy of the Lender Key benefits of Mortgage Guarantee MG offers mortgage lenders the following benefits Reduces capital requirements Reduces credit enhancement on securitization Improves ROEs Expands customer product offering Improves cash flows Improves risk management 08 09

6 Lower Capital requirements A Mortgage Guarantee has been recognised by the Reserve Bank of India as a valid Credit Risk Mitigant (CRM) under para 7.5 of the Master Circular Prudential Guidelines on Capital Adequacy and Market Discipline Implementation of New Capital Adequacy Framework (NACF). This means that from a lender and regulatory perspective, there is an element of risk transfer from the lending ecosystem to the balance sheet of the MGC. This risk transfer enables the lender to release capital as per the Basel rules, resulting in more efficient use of capital and enhanced Return on Equity (ROE) for shareholders from the same capital base. Capital adequacy requirement of various lenders is given in the table below. Table 4: Regulatory capital requirement & risk weights Entity Overall Capital Adequacy Tier I capital Requirement Risk weights Banks (Basel III) 11.5% 9.5% (by Mar-19 ) 35%, 50% and 75% HFCs 12% 6% 35%, 50% and 75% Source: RBI, NHB and ICRA Research Mortgage loans attract risk weights depending on the loan amount as given in the table below. Table 5: Risk weights and minimum Tier 1 capital requirements for mortgage loans Loan amount LTV Risk Weight Banks HFC Mar-15 Mar-19 Mar-15 Up to Rs. 3.0 million 80% 35% 3.3% 2.5% 2.1% > 80% and 90% 50% 4.8% 3.5% 3.0% Rs million 75% 35% 3.3% 2.5% 2.1% > 75% and 80% 50% 4.8% 3.5% 3.0% More than Rs. 7.5 million 75% 75% 7.1% 5.3% 4.5% Source: RBI, NHB and ICRA Research Therefore, minimum Tier 1 capital in relation to the loan extended by a Housing Finance Company (HFC), without a mortgage guarantee could vary from as low as 2.10% to 4.5%, while for a bank it would be 3.33% to 7.13% by Mar-19 respectively. Lenders however can reduce their capital requirements by taking MG on the underlying loans. Based on RBI regulation, risk weight on the lenders balance sheet for the MG covered portion of a loan would be based on the credit rating of the MGC. The risk weight for a AA rated MGC would thus translate to 30%, as against 35%/50%/75% required on home loans not covered by MG. The capital release for lenders at a given credit rating of a MGC is driven by a combination of the extent of MG coverage taken and the factors in Tables 4 and 5. The following illustrates the possible release of capital for a lender taking a top cover MG on home loans which attract a 75% risk weight. 8 Under BASEL III, banks are required to increase their minimum capital adequacy and Tier 1 capital requirements to 11.5% and 9.5% by March 2019, against 9% and 7% in March 2015 respectively 10 Table 6: Minimum tier1 capital release on home loan with 75% risk weight guaranteed by a AA rated MGC A B C=AxB D E=C-D Tier 1 capital in relation to risk weighted assets Risk weight on home loan, ticket size <Rs. 7.5 million Tier 1 capital requirement on loan with 75% risk weight of the lender without MG Tier 1 capital requirement of the lender with MG Regulatory capital release Extent of MG cover 11 Banks HFC HFC At minimum regulatory Tier 1 capital Mar-15 Mar % 9.5% 6.0% 12% 75% 75% 75% 75% Maintaining Tier 1 capital of 12% 0% 5.25% 7.13% 4.50% 9.00% 10% 4.94% 6.70% 4.23% 8.46% 20% 4.62% 6.27% 3.96% 7.92% 30% 4.31% 5.84% 3.69% 7.38% 10% 0.31% 0.43% 0.27% 0.54% 20% 0.63% 0.85% 0.54% 1.08% 30% 0.95% 1.28% 0.81% 1.62% Refer to the annexure 2 for the detailed computation for the 30% MG coverage As seen in the table above: Lenders can save significant Tier 1 capital by opting for a mortgage guarantee cover. As illustrated above, at the minimum Tier 1 capital requirement and assuming all assets carry a 75% risk weight, a bank could save 0.43% %, while HFCs 0.27% to 0.81% of Tier 1 capital depending on the extent of MG cover taken. Lenders typically maintain excess Tier 1 capital, in which case capital relief would be higher. Based on the above assumptions an HFC with a Tier 1 capital of 12% could enjoy a Tier 1 capital relief of 0.54% to 1.62% by taking a MG cover. Core Tier 1 capital requirement under Basel III for banks will increase to 9.5% by Mar-19 against 7.0% in Mar-15, and thus capital savings will increase (1.28% for 30% MG cover by Mar-19 against 0.95% in Mar-15). Thus, banks can take MG cover on their portfolio to meet a part of their large Tier 1 capital requirement under Basel III. Release of economic capital Regulatory capital requirement is a uniform prescription across all lenders. However, the assessment of economic capital requirement for any Lender is based on various qualitative and quantitative factors, including the following: Comfort with the top management/ promoter group of the company Risk appetite of the Lender as demonstrated by its target borrower segment, geographical spread, and key underwriting norms and processes followed vis-à-vis other industry peers Asset quality and profitability of the business, as demonstrated by past and present performance of Lender s portfolio

7 Risk control mechanisms/ robustness of MIS systems Prevailing operating environment and its likely impact on the Lender and its portfolio in the near to medium term Rating of the Lender Economic Capital requirement for AA rated HFCs usually varies between 8% and 12%, depending on the factors mentioned above (as opposed to uniform regulatory Tier 1 capital requirement of 6% for all HFCs). This capital acts as a mitigant against unexpected losses that may be borne by the Lender under stress (say, prolonged slowdown witnessed in the operating environment, resulting in job losses and crash in property prices). The economic capital requirement for any Lender would be lower in case it takes a guarantee cover on its portfolio, as some degree of credit risk in the portfolio is transferred to the MGC. Such a release of economic capital can allow a lender to maintain its credit profile while achieving higher business volumes against a given capital base. Alternatively a lender could improve its credit profile by lowering its economic capital requirement by taking a MG against a given level of business volumes. The extent of economic capital release (from the initial level required) would be determined by the following additional factors (other than factors mentioned earlier): Nature of MG product Quota Share or Top Cover Extent of loss cover available from MGC Extent of portfolio covered by MG product Norms adopted by MGC for selecting loans to guarantee and claim settlement process Expected claim acceptance / rejection rate based on experience over time Rating of the MGC In ICRA s assessment, for a typical AA category rated Lender, the extent of reduction in economic capital requirement, on the portion of the portfolio covered by a MG (provided by a AA rated MGC) may broadly be as per the table given below. Table 7: Possible* Reduction in Economic Capital Requirement Nature / Extent of MG Cover 10% 20% 30% Extent of reduction in economic capital required 20% -30% 40% - 50% 65%-75% *The quantum of capital release actually possible can only be determined after ICRA carries out a detailed evaluation of the Lender s portfolio guaranteed by a MGC Based on the table above, for an AA rated Lender, the reduction in economic capital requirement may be 65% - 75% for 30% Top Cover MG product. However, the benefit for a AAA rated Lender would be lower than illustrated above. For instance, the reduction possible in economic capital may be 45% - 50% for 30% Top Cover MG product. The benefit of MG cover on a Lender s portfolio would change in case of a change in the credit rating of the MGC. Also, the capital release, illustrated above, is applicable on the portion of the capital required on account of credit risk (and not pertaining to market risk or operations risk). However, the capital required for credit risk is likely to dominate the overall capital requirement, for instance credit risk weighted assets constituted around 86% of total risk weighted assets for Indian Banks as on March 31, Further, ICRA acknowledges that MG cover can also bring down the lender s operational risk, with the portfolio undergoing an additional round of review and due diligence by the MGC. Overall, as the economic capital requirement for a high investment grade rating (AA to AAA) is significantly higher than regulatory requirement, sometimes lack of an adequate level of economic capital becomes a constraining factor for growth for the credit profile. In this situation, a lender could release significant economic capital by taking a mortgage guarantee cover, capital thus released could be further leveraged to increase the business volumes or to meet economic capital deficit or to reduce its cost of funds with an improved credit rating Lowering of credit enhancements on securitization transactions The benefit of MG cover in an Originator s portfolio being securitized can also get reflected in the form of lower credit enhancement requirement, than what would have been required in the absence of MG cover for a similar target rating. The actual reduction in credit enhancement would depend on the underlying transaction structure, target rating of the transaction and a detailed analysis of the Originator s portfolio and pool to be rated by ICRA. Lower credit enhancements in turn would release capital for the originator. As a broad benchmark, for a target rating of AAA, and assuming a par securitisation transaction in which residual excess collections (after meeting scheduled investor payouts) are paid out to the Originator on each payout date, the extent of reduction in credit enhancement may broadly be in the region of 45% - 50% for 30% Top Cover MG product. The corresponding reduction in regulatory Tier 1 capital requirement for Banks (assuming 75% Risk Weight for assets being securitised) for a typical AAA rated mortgage loan securitisation transaction can be as per the Table given below. Nonetheless, it must be highlighted that the extent of reduction in credit enhancement could be lower if the credit enhancement is low in absolute terms, to cover the liquidity risk in the transaction (i.e. to mitigate against interim delinquencies in the pool until the money is received from MGC against these delinquent contracts). Table 8: Impact of MG Cover on Tier 1 capital requirement for Banks post securitisation with increased capital requirements under BASEL III Principal amount securitised/ assigned Credit enhancement stipulated Capital required by Originator prior to securitisation Capital required by originator post securitisation Extent of regulatory capital release for Originator on account of MG cover alone (prior to securitisation) Extent of additional regulatory capital release for the Originator on account of securitisation Extent of total regulatory capital release on account of both MG cover and securitisation Without MG cover With 30 % MG (Top Cover) Mar-15 Mar-19 Mar-15 Mar As can be seen in the table above, there is a significant amount of regulatory Tier 1 capital release for the banks on account of MG cover on the underlying loans post securitization, especially given the increase in Tier 1 capital requirements under BASEL III by March

8 Impact on Return on net worth Using the MG product could result in an improvement in ROE for the lender. The impact of mortgage guarantee standalone and MG as credit enhancement for securitization transactions would be a function of: Capital relief Reduction in credit cost Guarantee fee In addition to the above, the economics of a MG transaction for a mortgage lender would also depend upon the whether the lender or borrower is servicing the guarantee fee. In case of bulk transactions the guarantee fee is paid by the lender, which being an up-front payment, would have to be amortised over the tenure of the mortgage loan to assess the impact on the lender s ROE. However incise of a flow product, the guarantee fee could be paid by either the lender or by the borrower depending upon arrangement and product offered. Lenders typically can incentivize a borrower to pay the premium by offering: Lower down payments on a loan, or conversely a higher loan amount for a given level of down payment Elongation of loan repayment tenures, which could bring down the EMI or increase the loan amount eligibility of the borrower The following figure illustrates the potential improvement to the ROE which can be achieved by taking a Top cover MG at a varying level of MG coverage Impact on the ROE for Securitisation transactions MG could provide greater impetus to the securitization market as the requirement of credit enhancement to be provided by the Lender would come down if the underlying loans included in the securitized pool had MG cover. The actual reduction in credit enhancement would depend on the underlying transaction structure, target rating of the transaction and characteristics of the Lender s portfolio and specific pool to be rated, in addition to the nature of the MG product (Quota or Top Cover), extent of MG coverage, and rating of the MGC. Figure 9: Return on equity for a typical HFC in various scenarios Figure 8: Return on Equity for a typical HFC required to maintain 10% Economic Capital Source: ICRA Research As figure 10 shows, the impact on the return on equity for an HFC improves with securitization done with a mortgage guarantee with a 30% top cover. Source: ICRA Research As shown in figure 9, the size and type of MG cover have a key bearing on capital relief; the higher the MG cover, the higher the capital relief, and the larger the improvement in the ROE. 9 Assumed to be entirely First Loss Facility 14 15

9 Improves lender product offering Credit protection available to mortgage lenders through MG could facilitate an enhancement of lender product offering, benefitting customers through the following: Higher Loan to Value (LTV) ratio on the underlying property (for example, a lender may be willing to offer an LTV of 90% on a contract with MG cover as opposed to 80% LTV on a standalone basis) Loans with longer repayment period than otherwise have been offered without a MG. Extension of loan repayment tenures, could lower borrower EMI or increase their eligibility for a higher loan amount Credit protection available through a MG could also help lenders expand the breadth of customers they could target Furthermore India s mortgage credit market is expected to register a healthy growth supported by the emergence of the new customers segments given the GoI s push for housing for all by Access to MG product could be an enabling factor for lenders to increase their presence in undertapped customer segments, such as the affordable housing segment, given the credit risk protection available to them with a MG Improves lender cash flows MG coverage enables a lender to receive cash flows on delinquent contracts once classified as NPA (90+ day overdue). After a claim is filed and approved, the MGC would clear all overdues (principal and interest) and makes repayment of EMIs of the housing loan until the earlier of (i) borrower becomes current on EMIs, (ii) settlement of incurred loss following disposal of the collateral, or (iii) total claim payments equal the max amount of coverage. A MG thus helps a lender to manage its cash flow during the period in which a customer has defaulted or until a settlement / foreclosure is concluded. Illustration: A lender with a home loan in default with a 12 year residual maturity covered by a top cover MG with 30% coverage would be able to recover all installments (including interest) from the MGC for 2 years. In the case of a quota MG with 30% coverage, the lender would be able to recover 30% of installments for the next 6.8 years. Besides helping a lender to manage its cash flow during the period in which a customer is in the default presence of a MG can also help lender and the borrower arrive at a settlement, with any shortfall (either principal or interest) being recoverable from the MGC, subject to the maximum amount of coverage. Settlement however would require the consent of the MGC Improves risk management for lenders MG provides Lenders with a tool to manage their credit risk given that a proportion of risk would stand transferred to the MGC. Engagement with a MGC could also improve the underwriting quality for Lenders, as each loan guaranteed by a MGC would pass through its internal credit screens. Furthermore, post the MG deal, insights from the analytics and performance trends of contracts guaranteed by a MGC could help lenders better understand the portfolio performance and improve risk monitoring. Additionally Lenders could achieve greater operational efficiency through the additional layer of checks and balances required under the MGC s due diligence process. Over time this will lead to standardization of practices and processes across the industry if lenders want to use MG as a CRM Impact on mortgage penetration and customer behavior Overall in ICRA s view MG is an important tool for the expansion of the mortgage market in India. The release of capital for lenders facilitated by the MG product would allow them to achieve higher business volumes for a given capital structure, which could contribute towards increase of mortgage finance penetration in the country. Additionally MG benefits accruing to a lender, through higher potential return on capital and lower credit risks, could in turn be passed on to borrowers through lower down payments, or through favorable lending terms making mortgage credit more affordable to borrowers, thereby stimulating demand. Lower down payments however could impact borrower repayment behavior in the event of a sharp correction in property prices. Such risks however could get partly mitigated, provided lenders exercise prudent customer debt servicing underwriting norms, as a majority of India s mortgage credit market is to self-occupied home loan customers who have a lower propensity to default in the event of a correction in the value of their homes. Additionally the Loan to Value LTV ceiling of RBI also safeguard against risks of competitive pressures on minimum borrower equity. Table 9: RBI LTV ceilings for mortgage lenders Loan Size Up to Rs. 3 million Rs million > Rs. 7.5 million LTV regulatory ceiling 90% 80% 75% Source: RBI and ICRA Research 10 With a rate of interest of 10.5% and assuming the same does not change over the residual tenure 16 17

10 Introduction to India Mortgage Guarantee Corporation Private Limited India Mortgage Guarantee Corporation Limited (IMGC) is India s first mortgage guarantee company and provides credit protection to lenders on their home loans or a pool of home loans through its mortgage guarantee (MG) products. IMGC is setup as a joint venture of the following partners: International Finance Corporation (IFC) IFC, member of the World Bank Group, is the largest global development institution focused exclusively on the Private Sector. IFC helps developing countries achieve sustainable growth by financing investment, mobilizing capital in international financial markets, and providing advisory services to businesses and governments. An IFC representative is appointed on the board of IMGC. Asian Development Bank (ADB) ADB is owned by 67 members, including 48 from the Asian region. ADB helps its developing member countries reduce poverty and improve quality of life through policy dialogues, loans, equity investments, guarantees, grants, and technical assistance. An ADB representative is appointed on the board of IMGC. IMGC is a board managed company with close involvement of the key shareholders through their respective board representations. Figure 10: Key milestones of IMGC About the key shareholders National Housing Bank (NHB) NHB, a wholly owned subsidiary of the Reserve Bank of India (RBI), is the regulator and supervisor for Housing Finance Companies. IMGC benefits from NHB s in-depth understanding of the domestic housing finance market and participants. ICRA has a long term rating of [ICRA]AAA (stable) to the long term debt programme of NHB. Genworth Financial Mauritius Holdings, Ltd. Genworth Financial, Inc. is a Fortune 500 company with roots tracing back to Genworth is a global insurance provider offering a range of products including mortgage insurance, annuities, life insurance, and long term care insurance. Genworth operates through an extensive global network with a presence in more than 25 countries and had a mortgage guarantee risk in force of US $29 billion in December Genworth Holdings Inc is rated by Moody s Investor Service at Ba1 (negative). IMGC leverages Genworth s extensive experience of operating in the mortgage guarantee industry globally. Genworth is a technical service partner in the JV and provides IMGC with its in-house technical support and systems. Source: IMGC and ICRA research 11 Ultimate owner of Genworth Financial Mauritius Holdings, Limited 18 19

11 4.1. ICRA s credit rating on IMGC IMGC is rated by ICRA at IrAA (pronounced Issuer Rating double A) with a Stable outlook. This is the high-credit-quality rating assigned by ICRA. The rated entity carries low credit risk. The rating is only an opinion on the general creditworthiness of the rated entity and not specific to any particular debt instrument. The outlook of the rating is Stable. ICRAs rating factors in the strong profile of the company s shareholders National Housing Bank (NHB) (rated by ICRA at [ICRA]AAA for its long term bonds), Genworth Financial Mauritius Holding Limited (Genworth), International Finance Corporation (IFC) and Asian Development Bank (ADB), and the benefits IMGC derives from NHB s in-depth understanding of the domestic housing finance market and participants, along with Genworth s operating expertise in managing mortgage guarantee businesses internationally. The rating factors in the strong commitment from IMGC s shareholders to keep it well capitalized following an annual capitalization assessment process as per which, based on portfolio performance, estimated future stress losses and projected growth, IMGC will budget for any additional capital in advance. The rating is constrained by the untested nature of the mortgage guarantee business in India, likely concentration risk in the initial ramp up period and the nascent stage of the company s operations, with a guarantee in force of Rs billion as on Mar-15. Ability of the company to manage portfolio risks, including adverse selection risks on contracts guaranteed, and also charge premiums efficiently in relation to underlying risks as it scales-up its operations are important rating sensitivities. ICRA however notes the moderate expected build-up in operations, intended selective approach and expertise the company derives Genworth in managing mortgage guarantee businesses internationally IMGCs business profile IMGC commenced its operations with its first transaction in March The company had a guarantee in force that was Rs billion as on March 31, 2015 across three originators. IMGC extends mortgage guarantees on contracts after conducting a due diligence on contracts based on several filters including loan to value ratios, customer profile, fixed obligation to instalment ratio and geographic concentration. IMGC has provided MGs across a spectrum of origination and customer profiles. The following table summarises transactions done by IMGC Table 10: Summary of transactions done by IMGC so far Date Lender Type of Type of Nature of product product origination Mar-14 Dewan Housing Credit enhancement Bulk Finance Corporation Dec-14 Home First Seasoned Flow Bulk Finance Company Mar-15 Reliance Seasoned Flow Bulk Home Finance Oct-15 Sep-15 ICICI Bank Flow Flow IMGC provided a first loss guarantee on a pool housing loans. The MG coverage was 30% at a loan level, subject to total ceiling of 10% of total pool IMGC provided guarantee on a part of the existing book to improve the leverage and lower the cost of debt as risk was transferred to IMGC IMGC provided a first loss guarantee over 2 transactions to cover substantial portion of the company s seasoned book based on their requirement of risk transfer First loss MG is extended to customers to enhance loan LTVs by up to 20%, subject to regulatory LTV ceiling International Finance Corporation (IFC) IFC, member of the World Bank Group, is the largest global development institution focused exclusively on the Private Sector. IFC helps developing countries achieve sustainable growth by financing investment, mobilizing capital in international financial markets, and providing advisory services to businesses and governments. An IFC representative is appointed on the board of IMGC. Asian Development Bank (ADB) ADB is owned by 67 members, including 48 from the Asian region. ADB helps its developing member countries reduce poverty and improve quality of life through policy dialogues, loans, equity investments, guarantees, grants, and technical assistance. An ADB representative is appointed on the board of IMGC. IMGC is a board managed company with close involvement of the key shareholders through their respective board representations Strong support from shareholders IMGC is a board-managed company with close involvement of the JV partners through their respective board nominations. The board exercises strong oversight over the company s business plans and roll-out strategy. IMGC derives significant support from NHB by leveraging its in-depth understanding of the domestic housing finance market, participants, and market trends. IMGC also leverages Genworth s extensive experience of operating in the mortgage guarantee industry globally. Genworth is a technical service partner in the JV and provides IMGC with its in-house technical support and risk management systems and has also helped formulate IMGCs lender selection and contract selection criterion. IMGC enjoys strong capital commitments from its shareholders. The shareholders infuse capital in advance based on an annual capitalization assessment process based on IMGCs portfolio performance, estimated future stress losses and projected growth. As on March 31, 2015 IMGCs Tier 1 capital was % against the regulatory minimum of 10%. ICRA s rating factors in the expectation that capital and liquidity support from IMGC s shareholders would be forthcoming incase of need IMGC in early stage of its roll-out Since IMGC is a relatively new company it is in the process of scaling its operations and its earnings profile is expected to stabilize only in the medium term. Earnings of the company in the medium term would critically depend upon its ability to charge premiums efficiently in relation to underlying risks as it scales-up its operations as well as achieves scale efficiencies. IMGC conducts due diligence on contracts based on several criterion including loan to value ratios, customer profile, fixed obligation to instalment ratio and geographic concentration. Although IMGC s guaranteed contracts have limited seasoning, such contracts have exhibited low delinquencies so far. ICRA notes IMGC s moderate expected build-up in operations, intended selective approach and the expertise it derives from Genworth in managing mortgage guarantee businesses, These factors along with the expected improvement in economic environment and stable industry delinquency levels should help IMGC manage risks as it grows. Source: IMGC and ICRA Research 12 Genworth Financial Mauritius Holding Limited is ultimately owned by Genworth Holdings Inc, which is rated by Moody s Investors Service at Ba1/Negative for its long term debt 20 21

12 Processes followed by IMGC Annexure Partner selection Type of MG product and pricing Underwriting by IMGC Instance of default/claims filing Ÿ MGC undertakes a due diligence of the lender's portfolio, credit policies, underwritting and collection processes Ÿ Based on detailed interactions with the Lender, IMGC will assess the requirements of the Lender- accessing new markets, cover on existing book, securitisation, etc Ÿ Based on requirements an existing pool (bulk) or fresh originations (flow)) for MG, a detailed proposal is developed Ÿ Pricing of MG determined by the following factors Ÿ MG Coverage level Ÿ Type of product (Quota Share or Top Cover) Ÿ Key risk criteria such as Loan To Value ratio ( LTV ), loan amount, and borrower profile Ÿ Loan seasoning (for bulk and seasoned flow products) Existing Book Ÿ IMGC appraisal could be on a contract wise basis or done on a sample basis based on the track record with the lender. IMGC appraisal includes validation of borrower details, credit scores, property valuation and LTVs., among other criterions Ÿ Lender and IMGC sign MG Agreement governing the business relationship New Book Lender and IMGC sign Master Policy that sets forth the requirements for both parties and governs the business relationship IMGC set norms and data requirements. Contracts meeting IMGCs internal credit screens are approved for MG IMGC would appraise the loans based on the credit norms determined in the master agreement Premium is paid up-front either by the lender or the customer depending upon agreement between them Ÿ Lender can file claim after account turns NPA (90+ days overdue) Ÿ IMGC checks for compliance of lender with respect to collection proceeduers adopted and documentation of contract Ÿ Incase claim is approved. MG will make the repayment of EMIs of the housing loan until the earlier of the following: (i) borrower becomes current on EMIs, (ii) settlement of incurred loss following disposalof the collateral, or (iii) total claim payments equal the max amount of coverage Annexure 1: Trends in property prices According to the Residex data published by NHB for September 2014, 20 cities out of 26 covered in the index have shown an annual increase in property prices while 6 cities witnessed an annual decline. The following tables present the movement in the index for the Top 5 cities that reported an increase and the movements for the six cities that reported a decline in property prices over the same horizon. Table 11: Top 5 Cities where Real Estate Prices Increased in Q2FY15 on y-o-y basis CITIES 2007 Source: NHB Apr- Jun 2012 Jul- Sep 2012 Oct- Dec 2012 Jan- Mar 2013 Apr- Jun 2013 Jul- Sep 2013 Oct- Dec 2013 Jan- Mar 2014 Apr- Jun 2014 Jul Growth Y-o-Y Sept Q2FY15 Growth 2014 Chennai % 13.8% Ahmedabad % 13.6% Nagpur % 11.1% Pune % 10.5% Surat % 10.3% Table 12: Cities where Property Prices Declined in Q2FY15 on y-o-y basis CITIES Source: NHB 2007 Apr- Jun 2012 Jul- Sep 2012 Oct- Dec 2012 Jan- Mar 2013 Apr- Jun 2013 Jul- Oct- Sep Dec Jan- Mar 2014 Apr- Jun 2014 Jul Growth Sept Q2FY Y-o-Y Growth Meerut % -9.7% Chandigarh % -9.4% Jaipur % -6.5% Vijayawada % -3.6% Ludhiana % -2.7% Delhi % -0.5% Although the data suggests some rise in property prices in some markets in Q2FY15, high inventory levels in certain locations, have resulted in builders offering discounts in the form of free parking spaces, furnishings and interest subventions, which may not reflect entirely in the index. At the same time an expected improvement in economic environment, softening of interest rates and improving borrower income could stimulate housing demand which could support housing prices

13 Annexure 2: Capital relief computation Table 13: An Illustration of capital release for banks and HFCs is given below Tier 1 capital in relation to loan Bank HFC Mar-15 Mar-19 Assumptions Guarantee Cover 30% 30% 30% Minimum regulatory requirement 7.0% 9.5% 6.0% Risk weight on home loan, ticket size <Rs. 7.5 million 75% 75% 75% Risk weight on covered portion provided by AA rated MGC 30% 30% 30% Capital Release computation A Capital in relation to loan Risk Weight x Tier 1 capital 5.25% 7.13% 4.50% (Without the Guarantee) B1 Capital for guaranteed Guarantee Cover x Risk Weight 0.63% 0.86% 0.54% portion based on credit rating of MGC x capital requirement B2 Capital for non guaranteed Non guaranteed part x Risk 3.68% 4.99% 3.15% portion Weight x capital requirement B= Capital in relation to loan 4.31% 5.84% 3.69% B1+B2 C= A-B Capital released for home 0.95% 1.28% 0.81% loan which attract a75% risk weight Capital released for home 0.42% 0.57% 0.36% loan which attract a 50% risk weight Capital released for home 0.11% 0.14% 0.09% loan which attract a 35% risk weight Source: ICRA research Annexure 3: Key Regulations for Mortgage Guarantee Companies (MGC) MGC s are regulated by the Reserve Bank of India. Key contours of the regulatory framework follows: Capital Requirements MGC s are required to have a minimum NOF of Rs. 1 billion Minimum Capital adequacy requirement is 10%. o Minimum Tier 1 capital requirement is 6%. o Tier 2 Capital not to exceed 100% of Tier 1 capital Risk weight on mortgage guarantees provided: Value of MG provided to be multiplied by a conversion factor of 50% to arrive at credit equivalent value. The aggregate risk weighted value is arrived at by multiplying the credit equivalent value with the applicable risk weight, as detailed in the table below. Table 14: Risk weights applicable on home loans Loan amount LTV Risk Weight Up to Rs. 3.0 million 80% 35% Source: RBI and NHB > 80% and 90% 50% Rs million 75% 35% > 75% and 80% 50% More than Rs. 7.5 million 75% 75% Requirement for creation of a contingency reserve The mortgage guarantee company is required to create a Contingency Reserve on an ongoing basis: (a) Appropriate each year the higher of a) forty percent (40%) of the premium or fee earned during that accounting year b) twenty five percent (25%) of the profit (after provisions and tax), whichever is higher, In case of inadequate profits, such appropriation shall either result in or increase the amount of carry forward loss; (b) a lower percentage of the premium or fee earned may be appropriated, subject to a minimum of 24%, during any accounting year when the provisions made each year towards losses on account of settlement of mortgage guarantee claims exceeds thirty-five percent (35%) of the premium or fee earned during that accounting year; (c) Contingency Reserve is required to be built up to at least five percent (5%) of the total outstanding mortgage guarantee commitments; (d) amounts appropriated each year to the Contingency Reserve are required to be maintained for a minimum period of seven (7) subsequent years which shall be eligible for reversal only in the eighth year subject to the condition in above; (e) Shall utilize the Contingency Reserve without the prior approval of the Reserve Bank of India solely for the purpose of meeting and making good the losses suffered by the mortgaged guarantee holders only after exhausting all other avenues and options to recoup the losses; in all other cases of utilization, prior approval of Reserve Bank of India shall be obtained. Exposure Norms No single guarantee shall exceed 10% of Tier1 + Tier 2 of the MGC LTV ceilings on home loans guaranteed by a MGC are 24 25