TEACHERS RETIREMENT BOARD INVESTMENT COMMITTEE. SUBJECT: Home Loan Program 2012 Mid-Year Report CONSENT: X ATTACHMENT(S): 1

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1 TEACHERS RETIREMENT BOARD INVESTMENT COMMITTEE SUBJECT: Home Loan Program 2012 Mid-Year Report ITEM NUMBER: 4c CONSENT: X ATTACHMENT(S): 1 ACTION: DATE OF MEETING: September 7, 2012 INFORMATION: X PRESENTER(S): Solange Brooks and Michael Warmerdam POLICY The Home Loan Program (HLP) is governed by the CalSTRS Home Loan Program Policy (Board Policy Manual, Section 1000, Pg. F-1), adopted by the Teachers Retirement Board in November 1986 and last revised on February 2, HISTORY During the February 2011 presentation of the HLP s annual report for 2010, the board requested semi-annual reports for the next two to three years for enhanced visibility during challenging times in the housing market. It is anticipated that mid-year reports would continue until 2013 or 2014, per the preference of the Investment Committee. PURPOSE The mid-year report was created to provide the Investment Committee with information on significant activities and developments that have occurred since the HLP s last annual report (February 2012). The report contains the latest metrics concerning production, performance, delinquencies, and default activity. Also included is an update on the progression of our efforts to establish a new master servicing agent/program administrator via the request for proposal process, and changes to the proposed mortgage program to be offered. For the benefit of the newer members of the Committee, and as a general review for the others who may have interest, staff has provided a glossary of terms relevant to mortgage loan financing in the report. CONCLUSION The attached report examines the state of the CalSTRS HLP in key measurable areas, and summarizes developments in our efforts to reestablish program activity. Prepared by: Prepared by: Approved by: INV61 Michael Warmerdam Solange F. Brooks Christopher J. Ailman, Investment Officer Investment Officer Chief Investment Officer

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3 Mid-Year Report Home Loan Program Securing the Goal of Home Ownership Securing the Goal of Home Ownership INV63

4 Securing the financial future and sustaining the trust of California s educators 2 Home Loan Program INV64

5 Contents Introduction 4 Recent Developments 4 Production 5 Portfolio Performance 6 Delinquency Data 6 Default Activity 8 Home Connection Program 10 Conclusion 10 Glossary 11 Securing the Goal of Home Ownership 3 INV65

6 CalSTRS Home Loan Program Introduction The California State Teachers Retirement System (CalSTRS) Home Loan Program (HLP), was originally created as a result of legislation in It was designed to add member value by providing CalSTRS members with access to homeownership in California via a market rate mortgage loan, while concurrently meeting the investment goals of the system by generating a mortgage asset. The HLP started with conventional 15 and 30 year fixed-rate products but evolved over the years in response to the needs of our members. This evolution resulted in the development of low down payment products such as the 95/5 and 80/17 Programs that support the practical homeownership ambitions of our members. Last fall, new mortgage originations were suspended due to the strategic decision by the program s master servicing agent and program administrator to exit the correspondent lending business nationwide. Recent Developments Although mortgage originations remain suspended at the moment, we recently finished developing a Request for Proposal (RFP) for a new master servicer/program administrator. This RFP is scheduled to be issued by September During the drafting process, we asked CalSTRS counsel to review legislation underlying the Home Loan Program; specifically, language in Teachers Retirement Law, Section 22360(b)(4), regarding mortgage insurance. Outside counsel concluded that while arguments against requiring mortgage insurance can be made, the more likely interpretation is that CalSTRS require mortgage insurance on any directly held mortgages. This position impacted our original plans for the Home Connection Program, which had included the purchase of second liens to be held by CalSTRS. Subsequently, we were unable to find an insurer willing to insure second lien mortgages, and so we considered other design possibilities for the program. Fortunately, by structuring the Home Connection Program as an affordable mortgage for underserved markets, we will be able to offer what we believe will be a compelling program with the lowest mortgage insurance coverage requirements available. It will include a low down payment, a conforming first lien 1, and no second lien. This is the fundamental program structure included in the RFP; however, we may develop and introduce favorable variations in the future as the program evolves. A comparison of the anticipated program with the original proposal is included as Appendix 1. 1 securitized by one of the Government Sponsored Entities (GSEs) 4 Home Loan Program INV66

7 Production As of June 30, 2012, total funding since the inception of the program stood at approximately $6.1 billion, which was comprised of 44,882 mortgages. Exhibit 1 $7 Amount Funded ($ Billions) 44,882 Loans $6 $5 $4 $3 $2 $1 $0 New activity has remained flat since we suspended originations. During this time, we focused our efforts on developing a new mortgage program, constructing an RFP for a new master servicing agent/program administrator, and managing servicing related inquiries. Exhibit 2 Annual Funding Volume ($ Millions) $1,000 $750 $500 $250 $- $728 $566 $281 $284 $93 $3* *2012 purchase activity is residual from 2011 applications already in process. Securing the Goal of Home Ownership 5 INV67

8 Portfolio Performance As of June 30, 2012, the market value of mortgage assets retained in the CalSTRS HLP s portfolio was over $410 million. Exhibit 3 HISTORIC RATE OF RETURN PERFORMANCE* HOME LOAN PROGRAM PORTFOLIO DEBT OPPORTUNITY POLICY BENCHMARK Year Years Years 5.05% 7.63% 8.64% 7.48% 7.39% 7.16% * As of June 30, Source: State Street Delinquency Data Our last annual report included a November 30, 2011, snapshot of delinquencies in the portfolio. At the time, the total delinquency rate was 2.75 percent and the total number of active first lien mortgages originated through the CalSTRS HLP was 5,875. As of June 30, 2012, this delinquency rate decreased slightly to 2.64 percent. The number of active first mortgages fell to 5,610 as new origination activity remained suspended and existing mortgages continued to be liquidated primarily through payoffs, but with some foreclosures/short sales as well. A snapshot of delinquencies at the end of the fiscal year is shown in the following chart. Exhibit 4 CalSTRS HLP Delinquencies (June 30, 2012) Change since Days Delinquent # of Loans Delinquency % of Active Total November 30, days % 0.00% 60-days % -5.88% 90-days % % 120-days % 19.05% Pre FCL % % Total % -4.00% 6 Home Loan Program INV68

9 Home price stabilization/recovery, and a reduction in the unemployment rate are the key factors to driving down delinquencies and reducing defaults. The persistent decline in home prices continued slightly, but was essentially flat as of the end of Q1 (Ref: Appendix 2). Unemployment remain stubbornly high (Ref: Appendix 3). May 2012 marked the 40 th month of double digit unemployment in California. Our last several reports have contained a graph which provides a comparative perspective to how HLP s monthly delinquency rate measures up to available state and national metrics. We have expanded this graph from January 2009 through June 2012, using historical state and national data made publicly available by Lender Processing Services (LPS) a leading provider of loan performance analytics. Exhibit 5 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Delinquent Mortgages California (excludes those in foreclosure) Nationwide (excludes those in foreclosure) CalSTRS (includes those in foreclosure) CalSTRS (excludes those in foreclosure) Source: State and National data provided by LPS Applied Analytics Securing the Goal of Home Ownership 7 INV69

10 Default Activity The table below (Exhibit 6) presents the default performance of deferred second mortgages generated through the 80/17 and 95/5 Programs which were previously offered by the CalSTRS HLP. The information included is grouped by vintage year using data available through June 30, Payments on these deferred seconds are not required during the first five years after origination. 2 At the beginning of the second lien s sixth year, all interest that accrued during the five year deferral period is capitalized (added to the principal balance), and the borrower is then required to make regular monthly payments until maturity. Loans that have transitioned from the deferred payment period to the required payment period are referred to as recast loans. Exhibit 6 CalSTRS HLP Portfolio (June 30, 2012): Second mortgage performance by vintage year Origination Active Inactive Year Qty Original Balance Recast Year Current 90+ days Del Remaining Principal Balance Paid off FCL or Short Sale Cumulative Amt Written-off $ 621, $ 227, $ 96, $ 1,670, $ 1,046, $ 674, $ 2,966, $ 1,058, $ 1,939, $ 14,425, $ 10,474, $ 5,061, $ 52,579, $ 43,898, $ 1,730, $ 120,954, $ 112,063, $ 614, $ 83,787, $ 80,342, $ 56, $ 42,658, $ 42,099, $ - $ 319,665,283 $ 291,211,729 $ 10,173,289 Data from the table is presented as a bar chart on the following page (Exhibit 7). Each bar represents a vintage year and is labeled with the total quantity of second lien mortgage originations during the year, and the percentage that is in default as of June 30, This percentage is calculated by adding the number of delinquent loans to the number of foreclosure/short-sale loans, and dividing this sum by the quantity originated during the year. The 2005 through 2007 vintages suffered greatly from having been originated at peak pricing in the housing market (Ref: Appendix 2). The portfolio has been fortunate that this 2 The associated first liens are fully amortized and represent 80% of the total amount funded for 80/17 mortgages, 95% for 95/5 mortgages. 8 Home Loan Program INV70

11 group accounts for only 6 percent of the HLP portfolio s deferred second originations. The vintages from 2008 through 2011 make up 94 percent of the portfolio s deferred second originations, and are expected to perform better as a consequence of having been originated after a significant amount of peak price depreciation had already occurred. Exhibit Status of Second Mortgages * June 30, days delinquent, foreclosures, and short sales Current and Paid off % % Loans % % % % % % Year of origination CalSTRS participates in the federal government s Making Homes Affordable (MHA) Program to include the Second Lien Modification Program (2MP). 2MP is designed to work in tandem with the Home Affordable Modification Program (HAMP) to provide a comprehensive solution for homeowners with second mortgages originated prior to 2009, who are experiencing a financial hardship. Our participation in 2MP works to mitigate the number of future defaults among the HLP portfolio s second lien mortgages that have reached recast. 2MP offers a lifeline to help eligible borrowers remain in their homes, and is preferable to the portfolio from a financial perspective than if the property were to go into foreclosure or short sale. * Each second mortgage reflects the status of the corresponding first lien mortgage, regardless of whether it has reached recast. Securing the Goal of Home Ownership 9 INV71

12 Home Connection Program As noted in the Recent Developments section of this report, there have been some changes to the originally proposed CalSTRS Home Connection Program. The revised program will include a low down payment feature, competitive fixed rates, and low mortgage insurance costs. It will be an affordable mortgage program targeting low-tomoderate income borrowers, as well as properties in underserved areas. 3 It will continue to provide the opportunity of home ownership for qualified participants, and it avoids second lien exposure to the portfolio going forward. We have included the fundamental structure in the RFP, and once we have selected a new master servicing agent/program administrator, we will work together to develop guidelines and finalize the details. At that time, we will work with the CalSTRS Communications Branch to inform members about the program via articles in existing newsletters, and we will update the information posted in the Home Loan Program section of the CalSTRS website. Staff will also represent the program at outreach events with our members. Conclusion We look forward to the completion of the RFP process and the selection of a new master servicing agent/program administrator. From there, we will work prudently, and as expeditiously as possible, to establish a new contract, develop program guidelines, establish a correspondent lending channel, and resume originations to qualified borrowers. We are focused on making the CalSTRS Home Connection Program an attractive mortgage offering for qualified borrowers, and a vibrant source of mortgage backed security investments for the retirement fund. 3 Designated by the Department of Housing and Urban Development (HUD) 10 Home Loan Program INV72

13 CalSTRS Home Loan Program GLOSSARY 80/17 Program - This previously offered program consisted of an 80% loan-to-value first mortgage and a 17% second mortgage that was deferred for the first five years of the 30-year mortgage term. The borrower would pay the remaining 3% of the purchase price at closing. 95/5 Program - This previously offered program consisted of a 95% loan-to-value first lien mortgage with a 5% deferred second mortgage. The program provided 100% financing with no down payment requirement. ALT-A - A category of mortgages which have a risk potential that is greater than prime but less than subprime. The interest rate offered on these mortgages is usually between the prime and subprime levels. The reason for the increased risk is usually not the borrower s credit history, but rather something specific about the mortgage. BASIS POINT - One hundredth of one percent;.01 percent in yield and.0001 in decimal form. BENCHMARK - An index that is used as the standard for comparison in measuring the performance of a given portfolio. BOARD - The California State Teachers Retirement System Board of Trustees. CALIFORNIA HOUSING FINANCE AGENCY (CalHFA, f.k.a. CHFA) - California agency with responsibility for supporting the needs of renters and first-time homebuyers by providing financing and programs that create safe, decent, and affordable housing opportunities for low and moderate income Californians. CONFORMING LOAN - A mortgage that meets the qualifying criteria set by Fannie Mae and Freddie Mac that make it eligible for purchase. One such requirement is that the loan must be equal to or less than the conforming loan limit set by Fannie Mae or Freddie Mac. A conforming loan carries a lower interest rate and generally more favorable terms than a jumbo loan. CONVENTIONAL LOAN - A mortgage in which the interest rate does not change during the entire term of the loan. Also, a mortgage that is not insured or guaranteed by the government, thus the lender bears more risk and generally has higher standards for qualification. For comparison, a loan guaranteed by the Veterans Administration (VA) or insured by the Federal Housing Administration (FHA) would not be a conventional loan. CORRESPONDENT AGREEMENT - The contract between CalSTRS and a private financial institution that originates and services loans and which describes the respective duties of each party. CORRESPONDENT LENDER - The private financial institution that originates and, in some cases, services home loans for CalSTRS' borrowers. DEFAULT - A participant is in default when the principal and interest payment due on Securing the Goal of Home Ownership 11 INV73

14 a loan has not been remitted for 120 days. DEED IN LIEU - A deed instrument in which a mortgagor (borrower) conveys all interest in a real property to the mortgagee (lender) to satisfy a loan that is in default and avoid foreclosure proceedings. A deed in lieu has a lesser negative impact on a borrowers credit score than a foreclosure. FEDERAL HOUSING FINANCE AUTHORITY (FHFA) - An independent federal agency charged to supervise, regulate and oversee the Government Sponsored Enterprises (GSEs). FHFA was appointed as the government conservator controlling Fannie Mae And Freddie Mac since they were bailed out in FNMA / FHLMC GUIDELINES - The specifications required by the Federal National Mortgage Association (FNMA) (Fannie Mae) or the Federal Home Loan Mortgage Corp. (FHLMC, Freddie Mac), in order to be eligible for guarantee as to principal and interest payments. FNMA and FHLMC are private corporations, federally chartered to provide financial products and services that increase the availability and affordability of housing for low-, moderate-, and middle-income Americans. GOVERNMENT SPONSORED ENTERPRISE (GSE) - Typically the term refers to Fannie Mae, Freddie Mac and Ginnie Mae. HOME AFFORDABLE FORECLOSURE ALTERNATIVES PROGRAM (HAFA) - A component of the federal government s Making Home Affordable Program (MHA). HAFA was created to assist homeowners who can no longer afford to stay in their home, but want to avoid foreclosure and transition to more affordable housing through a short sale or deed-in-lieu of foreclosure. HOME AFFORDABLE MODIFICATION PROGRAM (HAMP) - A component of the federal government s Making Home Affordable Program (MHA). HAMP is designed to enable borrowers that meet eligibility requirements avoid foreclosure by modifying loans to a level that is affordable for borrowers and sustainable for the longterm. This initiative is targeted at delinquent borrowers and those facing imminent risk of default with loans originated prior to January 1, The goal is a reduction in the borrower s mortgage payments to 31 percent of monthly income. HOME AFFORDABLE REFINANCE PROGRAM (HARP) - A component of the federal government s Making Home Affordable Program (MHA). HARP is designed to allow borrower s who meet eligibility requirements refinance their first mortgage into a more affordable mortgage. Among the requirements, the borrower must be current with payments, and the mortgage must have been sold to Fannie Mae or Freddie Mac on or before May 31, HARP does not apply to second mortgages. HOUSING AND URBAN DEVELOPMENT (HUD) - United States Department of 12 Home Loan Program INV74

15 Housing and Urban Development. A Cabinetlevel department in the Executive Branch of the federal government. HUD s mission is to create strong, sustainable, inclusive communities and quality affordable homes for all. INTEREST-ONLY LOAN - A loan in which interest is payable at regular intervals (usually monthly). Does not require amortization. JUMBO - Any single mortgage loan in an amount that exceeds the conforming loan limit set by Fannie Mae and Freddie Mac. Jumbo mortgages are not backed by Fannie Mae or Freddie Mac and carry greater risk. They therefore require the borrower to pay a higher interest rate than a conforming loan. Jumbo mortgages are a specific category of non-conforming loans that exceed the conforming size limitation. LOAN RATE - The cost of using money, expressed as a rate per period of time. LOAN-TO-VALUE RATIO (LTV) - The ratio of the loan amount to the appraised value of the property. Example: A property with a loan of $80,000 and an appraised value of $100,000 results in a loan-to-value of 80 percent. MAKING HOME AFFORDABLE (MHA) - A federal government plan to stabilize the housing market and help Americans reduce their monthly mortgage payments to more affordable levels. MORTGAGEE - The creditor or lender in a mortgage agreement. MORTGAGE INSURANCE - Insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan. It is insurance to offset losses in the case where a mortgagor is not able to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property. MORTGAGE-BACKED SECURITY (MBS) - A security that is issued by a federal agency, such as the Federal Home Loan Mortgage Corporation, or the Federal National Mortgage Association, that is backed by mortgages. Payments to investors are received out of the interest and principal of the underlying mortgages. MORTGAGOR - The borrower in a mortgage agreement. NEIGHBORHOOD ASSISTANCE CORPORATION (NACA) - A non-profit, community advocacy and homeownership organization with the goal of building strong, healthy neighborhoods nationwide through affordable homeownership. NON-CONFORMING - A loan not eligible for guarantee as to principal and interest by FNMA or other federally chartered housing agency, based upon the borrower s qualifying ratios and/or loan amount. PRIME - the group of borrowers deemed to be the most credit-worthy, indicated by a FICO score of 660 or above (per FHFA, OCC, & OTC) Securing the Goal of Home Ownership 13 INV75

16 RECAST - A feature in some types of mortgages where the remaining scheduled principal and interest payments are recalculated based on a new amortization table. Most often, a recast is associated with a negative amortization mortgage which must recast at some point so that the mortgage will be paid off by the end of its scheduled term. REPAYMENT PENALTY - A monetary penalty assessed against the borrower, designed to inhibit the borrower s ability to refinance. SERVICING AGENT - An institution with the capacity of a Master Servicer and the ability to originate mortgage loans and to provide administrative support for a residential mortgage lending program. SHADOW INVENTORY - According to real estate data provider First American CoreLogic, Inc., it is a measure of pending supply. Specifically, real estate owned (REO) properties as a result of foreclosures and other actions, such as deeds in lieu, as well as real estate that is at least 90 days delinquent. The term is generally used to encompass the segment of real estate properties that are either in foreclosure and have not yet been sold as well as homes that owners are delaying putting on the market until prices improve. Shadow inventory causes reported data on housing inventory to understate the actual amount of inventory in the market. history. UNDEREMPLOYMENT - A situation in which people in the labor force are employed at less than full-time or jobs or positions compensated below their level of skill and experience. UNDERSERVED AREAS - HUD Definition: A census tract in a metropolitan area is classified as an underserved area if median income for the tract is no greater than 90 percent of median income for the metropolitan area or if minorities comprise at least 30 percent of the tract s population and tract median income is no greater than 120 percent of area median income. A similar definition, based on counties, is employed for nonmetropolitan areas. HUD is the mission regulator for Fannie Mae and Freddie Mac, and has set a goal of at least 31 percent of the dwelling units financed by each GSE s mortgage purchases should be for units located in underserved areas. UNDERSERVED MARKETS - Borrowers at or below 140% average median income in California, or properties located in underserved areas. WHOLE LOANS - A secondary mortgage market term which refers to an investment in an original mortgage loan, versus a loan which participates in a secured pass-through security. SUBPRIME MORTGAGE - A mortgage loan for borrowers with less than excellent credit 14 Home Loan Program INV76

17 California State Teachers Retirement System Investments Branch Investments Executive Unit P.O. Box Sacramento, CA Securing the Goal of Home Ownership 15 INV77

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19 Appendix 1 Program Comparison CalSTRS Home Connection Program (Revised) CalSTRS Home Connection Program (Originally Proposed) Home Buyer Focus Employee of a California public school district or California community college and/or a member of CalSTRS, or a CalSTRS employee. Employee of a California public school district or California community college and/or a member of CalSTRS, or a CalSTRS employee. Eligible Properties Owner-occupied single family residences (1 unit only); condos meeting FNMA eligibility, and approved planned unit developments. Purchases only, not for refinances. Primary residence only. Owner-occupied single family residences (1 unit only); condos meeting FNMA eligibility, and approved planned unit developments. Purchases only, not for refinances. Primary residence only. Down 3% 5% Payment Term 30 Year (1 st mortgage only) 30 Year (1st and 2nd mortgages) Loan Amount Generally up to $417,000. $625,500 for FHFA designated Up to $417,000 (first mortgage portion) high-cost areas. Up to $495,187 (1 st and 2 nd combined) LTV 97% 80% 1 st mortgage 15% 2 nd mortgage 2 nd Mortgage N/A No deferral, fully amortized. Origination Fees Up to 1.00% Up to 1.25% (of first mortgage only; no origination fee on second mortgage). Discount None None Points Interest Fixed interest rate. Set daily by Rates CalSTRS. Rate Lock 45 days, one free float down. 60 days, no float down. Minimum To be determined. Proposal below. 700 FICO for Condos 720 for Condos Mortgage 18% coverage required. None Insurance Negotiating a discount with Requirement insurance providers will likely Maximum Income affect the minimum FICO offered. Up to 140% of Average Median Income, unless property is in an underserved location. Same fixed rate for 1 st and 2 nd mortgage. Set daily by CalSTRS. None Our Mission: Securing the Financial Future and Sustaining the Trust of California s Educators INV79

20 FHFA House Price Index (2000=100, quarterly) Nationwide California 230 FHFA House Price Index Source: Federal Housing Finance Agency, not seasonally adjusted Appendix 2 INV80

21 Unemployment Rate Unemployment Rate California Nationwide June marks the 41st month of double digit unemployment in California Source: Bureau of Labor Staistics Appendix 3 INV81