In a move with broad ramifications for the California real estate and insurance markets, the Federal Home Loan Mortgage Corp., known as Freddie Mac, will begin requiring earthquake insurance on many California condominium complexes before it will purchase mortgages on the units.
It is believed to be the first time that quake insurance will be required as a condition on mortgages anywhere in the United States.
Freddie Mac's new policy may spread to other mortgage purchasers and direct lenders, and it will certainly increase pressure on California officials to address the earthquake insurance availability problems that have sprung up since the Jan. 17, 1994, Northridge quake.
The nation's second-largest mortgage purchaser faces millions of dollars' worth of defaults on mortgages to condos damaged in the Northridge earthquake and wants to limit its future risk in the most seismically vulnerable areas, including large portions of Los Angeles and Orange counties and the San Francisco Bay Area.
The action, effective July 1, directly affects lenders who want to sell their condo mortgages to Freddie Mac, which holds one in six U.S. mortgages. Borrowers in high-risk areas, in turn, will be required to show that their condo associations have purchased the expensive coverage.
"We've been waiting for this shoe to drop for several months," Marjorie M. Berte, director of the state Consumer Affairs Department, said Friday. "They're essentially saying, 'We can't deal with the defaults on the next quake.' "
Freddie Mac's reaction--shrinking from earthquake risk--mirrors that of the insurance industry. Faced with total insurance losses of more than $10 billion from the 6.7-magnitude quake, nearly all of the state's largest property insurers have either stopped writing new earthquake policies or drastically cut back on their writings.
That leaves open the question of where condo owners are going to find the coverage when their lenders start demanding it next summer. In large condo complexes that lack the coverage, owners may have trouble selling their units.
"I can't see this action being particularly beneficial to home sales," said E.S. Lyons, senior vice president in charge of mortgage banking at Great Western Bank.
Insurance Commissioner Chuck Quackenbush is pressing the state Legislature for action on the availability problem, but most observers have concluded that earthquake risk is so great that the ultimate solution is a nationwide risk-sharing pool for all kinds of natural disasters.
Freddie Mac used geological studies to rate each California ZIP code as either high, moderate or low risk. Quake insurance will be required in all high-risk ZIP codes; it will be required for certain kinds of structures, especially older ones, in moderate-risk ZIP codes, and it will not be required at all in low-risk ZIP codes.
Unfortunately, as Wood noted, California's population is densest in the areas of highest risk. In Los Angeles County, for example, 143 ZIP codes are high-risk, 377 are moderate-risk and only one--Avalon on Catalina Island--is considered low risk. In Orange County, 42 ZIP codes are rated high risk and 80 moderate risk.
Freddie Mac, like the insurers, experienced a much worse financial impact from Northridge than it had projected for a quake that size.
Bruce Wood, the agency's director of mortgage credit policy, declined to estimate Freddie Mac's losses except to say that mortgages on "hundreds" of units in the quake zone are in default and that losses are in the millions of dollars. And because the agency gave many quake victims a grace period on mortgage payments, the full impact has yet to be felt.
"We're going to see a lot of settling out even into 1996," Wood said in a telephone interview Friday from Freddie Mac's McLean, Va., headquarters.
Freddie Mac's rate of serious delinquencies and defaults on condo mortgages in the Northridge area is three times that for single-family homes, Wood noted.
Why the disparate impact? For one thing, condos tend to be structurally weaker, having multiple stories or containing street-level parking garages tucked under the housing units.
Equally significant is the ownership structure of a condo complex, where individual unit owners have joint responsibility for the project as a whole under a condominium association. In some cases after the Northridge quake, people whose own condo units were undamaged went into default because they couldn't afford the repair assessments on the damaged part.
Berte cited the case of a 100-unit condo complex in Granada Hills that suffered moderate structural damage but was knocked flat financially when a few owners failed to meet their assessments.