Capital Market Financing of Social Housing in Chile

1. Capital Market Financing of Social Housing in Chile Sergio Almarza Manager of PROFIV November, 2001

2. WHO IS CHILE? • Total population (millions) 15.2 • Per capita income (US$) 4,600 • New families per year 98,000 • Housing deficit (homes) 700,000 • Size of the housing market (new homes/year) 120,000 • Size of the capital market (millions US$, pension funds and insurance companies investments) 48,100

3. DEVELOPMENT OF THE HOUSING SECTOR IN CHILE • Chile began an important development of housing policies based on the free market when the subsidy on demand was introduced in 1978. • This was strengthened enormously by the creation of private pension funds in 1981, which made it possible to structure a sound local capital market, capable of offering long-term re-financing to private lenders, with sufficient financial resources for the volume of demand then in existence. • However, this development was only consolidated in the case of homes of medium value or higher. • For the remaining homes (almost two-thirds of the demand in numerical terms), the whole credit function and part of the real-estate function remained almost entirely in the hands of the State, through the Ministry of Housing and Town Planning (MINVU) and the State Bank (Banco del Estado).

4. DEVELOPMENT OF THE HOUSING SECTOR IN CHILE The concentration of the supply of lower-value housing in the hands of the State has prevented the serious deficiencies that have existed historically in the management of financial resources from being overcome: ·A high degree of default in mortgage loan portfolios, inconsistent with the sustained growth in employment and wage levels Default in the MINVU portfolio is 67% The vast majority of these families are in a position to pay off their loans, but fail to do so: a “non-payment culture” has been created. ·A growing divergence between the supply of state housing solutions and the demand of the population Particularly dramatic is the situation of hundreds of thousands of families who own “social” level homes and, as their income increases, wish to sell their present homes and buy something better. This they are unable to do, because the State has a monopoly in that segment of the market.

5. DIAGNOSIS IN 1990 In 1990, the government of the time called on the parts of the private sector with links in real-estate development, and on institutional lenders and investors, to form a working Commission in order to evaluate the development of the sector and formulate a plan of campaign to tackle the problems. The main conclusions of this Commission were as follows: ·There was an enormous unsatisfied demand for housing services. ·At the same time, a basic institutional framework was in place, along with the business capacity and financial resources to satisfy all the demand in a period not exceeding 15 years. · However, the private sector was not reacting, due to the presence of certain barriers, originating in the housing policy itself, which had existed for several decades (the main one being the direct participation of the State in the market). In the light of these conclusions, a new strategy was worked out, with the main objective of transferring the direct attention of the lower-income sectors from the State to the private sector.

6. JOINT VENTURE CHILE-USA • In order to implement the new strategy, the Chilean government signed a joint venture agreement with its North American counterpart, for developing an institutional financial framework to make it possible for the local capital market to be connected with the private funding of lower-priced homes. • The agreement was developed with the support of the United States Agency for International Development (USAID), an institution which provided technical assistance and credit guarantees to the tune of US$36 million, in order to set up a pilot scheme to provide private companies with working capital to create housing loans for purchasing social homes. This in turn would launch the development of a specialized self-supporting financial industry, dependent on private local resources. • The two governments recognized that the reforms contemplated required significant changes of attitude, to complement the new structures which were being proposed, and to create a renewed and more favorable atmosphere. With this aim, it was agreed with the member firms of the Chilean Chamber of Construction and a group of influential business leaders, to establish jointly an independent corporation – PROFIV – for promoting the new strategy.

7. RESULTS OF THE PILOT SCHEME • 20 new lending companies were set up: 9 operating with mortgage loans and 11 with home- leasing contracts. • 4 securitizing companies were set up. • Funds were put out to tender, for a working capital of US$36 million for the lending companies, repayable over 20 years, with 10 years’ grace for the payment of capital. • The demand for funds from the lending companies was over 3 times what was offered. • All this money is being used to finance the purchase of homes worth between US$9,200 and US$16,100. • Various securitizations of the loan portfolios have been carried out, positioned entirely in the local capital market (bonds with AA risk-rating). • This has already allowed the companies that were not awarded funds for working capital (from the US$36 million that were tendered) to obtain traditional financing through the banking system, in order to produce loans for the lower-income segments, building up a portfolio and later taking part in securitization processes.

8. THE PROFIV PROPOSAL For the poor segment It is proposed that the State should participate by ensuring the possibility of a home that meets at least the minimum standards required by society, for all the families in this segment. This corresponds to a home whose maximum price is equivalent to US$9,250, for which the State would contribute as follows: ·  Initial subsidy equivalent to US$2,300 at present value, but divided into 20 equal annual payments, with an interest rate equal to the cost of the government funds. The value of the title deed created when the benefit is granted would be tradeable on the stock market. ·   The subsidies would be assigned in real time by means of free competition, to the extent that the interested party obtains complementary financing from a private lender. ·  A subsidy would be granted to start off the complementary financing, amounting to US$230 for a brand-new house and US$690 for a used house. · A percentage of the subsidies may be applied exclusively to used homes, this being defined according to the state of the stock of homes in each city.

9. THE PROFIV PROPOSAL · Re-financing of private lenders would be via the securitization of loan portfolios and the placement of the bonds on the local capital market. ·  There would be a Loan Guarantee Fund, with government resources, to cover up to 75% of the loss per operation completed, in case of delinquency. ·  A second-level state bank would be structured to re- finance up to 30% of the loans granted, in the case of the sectors with highest risk, where securitization is more difficult. For the medium-low segment The solution is similar to the above with a maximum price of home equivalent to US$16,200, but without including a second-level state bank. For the segment in extreme poverty A special solution of home-occupation free of charge is proposed, for which the State would acquire used homes by public tender, with an upper limit of US$6,950 per house.

10. Year Ext. Poverty Segment Poor Segment Medium-low Segment Total Programs Number of Operations Forecast (thousands) 1 10 90 20 120 2 10 115 25 150 3 10 139 31 180 4 10 115 25 150 5 10 98 22 130 6 10 90 20 120 7 10 82 18 110 8 10 74 16 100 9 10 57 13 80 10 10 40 10 60 Total 100 900 200 1,200 THE PROFIV PROPOSAL PROFIV proposes a program of 1,200,000 subsidy operations over a period of 10 years, which would completely eliminate the housing shortage in Chile. The poor segment would make up the bulk of the program, with 900,000 subsidies. The medium-low segment would occupy 200,000, and the extreme poverty segment, the remaining 100,000.

11. WHY HAS IT TAKEN US SO LONG? • Even with majority support for the new strategy, it has still not come to fruition. • This can only be explained by our “Latin American culture” which makes it very difficult to take decisions for major changes and implement them quickly.

12. THE NEW HOUSING POLICY This year (2001) the Chilean government has at last decided to push through most of the new strategy: ·  It recognizes the segment of extreme poverty, with a totally subsidized minimum solution i.e. without a loan. ·  It creates conditions for treating the solvent poor and the lower-middle class separately, since they should obtain housing finance in the private sector. ·   Financing for these segments will be based on: - Subsidy on demand of up to US$3,300 to purchase homes worth up to US$14,000. - Subsidy for expenses arising from the loan of up to US$350. - Credit guarantee of State for 100% of any loss that the financial institution may incur on demanding settlement of a loan that is in default.

13. BUSINESS OPPORTUNITIES We believe that there are clear opportunities in two areas of the reform at present under way in Chile: ·  Securitization ·  Master servicing of mortgage portfolios