Buybacks Wearing on Industry; Fannie, Freddie and Wall Street; FHA & Condo Project Changes?

Pick an
overwhelming percentage, like 80 or 90%. Remember when residential loan
production wasn’t “that” percent agency? Non-agency loans are still out there
and periodically being securitized (just ask Redwood Trust in the jumbo
sector), but by most accounts the market is “dislocated.” And if you’re
a large bank, who is flush with cash from deposits, there is certainly no
urgency to securitize the product and move it off your books – just keep
earning the spread. But here is an update on the non-agency world.

Hey, what
would a week in mortgage banking be like without a huge new lawsuit to, once
again, cause everyone to wonder about being in this business? In this one, the FDIC
is suing
the big banks over mortgage debt losses.

In a
recent speech Federal Reserve Chairman Bernanke discussed issues impacting the willingness of financial institutions
to lend
.  Bernanke referred to the Federal Reserve’s April 2012 Senior
Loan Officer Survey
in which most banks indicated their reluctance to accept
mortgage applications from borrowers with less-than-perfect records is related
to “putback risk”–the risk that a bank might be forced to buy back a
defaulted loan if the underwriting or documentation was judged deficient in
some way. No surprise there, but the complete text of Bernanke’s remarks is
accessible here.

The GSE’s
have gone through, and are undergoing, a tremendous “brain drain” as
management and seasoned personnel leaving. (Of course, many talented people
remain.) But there is some thinking out in the industry that “we’ll get
what we pay for” going forward. And say what you will about the industry
needing the agencies (and I am a proponent of them in many roles), the uncertainty about Freddie & Fannie’s
future is impacting the business
– but there will no resolution until 2013,
after the election. There is no question that Fannie & Freddie set
standards in documentation & underwriting, add to liquidity, and give
investors stability. Elizabeth Duke, a governor at the Federal Reserve, said
the unresolved status of Fannie Mae and Freddie Mac is hurting the housing
recovery. “Uncertainty about the future on the part of lenders is
inhibiting these investments” in mortgage lending. She also noted that
uncertainty over regulations and the outlook for home prices is hindering
mortgage lending. This is certainly not a surprise to anyone in the business.

Along
those lines, looking back at the agency role 10 years ago, I received this
e-mail; “Fannie and Freddie were trying
to keep up with Wall Street
. Investment banks made the market, created
demand (because they had gobs of cash to invest that needed a home), and ended
up taking FNMA /FHMC market share simply by expanding the market size with this
product. Granted, the Agencies aren’t innocent, but Wall Street built the
infrastructure, and it was Wall Street who marketed it – they had a huge
liquidity appetite to feed.  The GSE’s had to follow to maintain share,
and because they had to get approval from Congress, they stupidly cloaked their
strategy in “Affordable Housing for all” – who wouldn’t vote for that? – especially
when Congress was not presented with the real risk picture.”

The note
continues: “I would say that the traditional depository banks such as Chase and
Wells and BofA had to try to follow the Street as well. But it was the Wall Street
Investment and trading Banks that created the securities and sales
infrastructure, product, and demand.  Once the product guidelines were
released into the secondary market, it became much cheaper and frictionless to
do that product, and have the borrower pay just a little more…..and oh by the
way – the Street was paying the originator way up for that product as well,
comparable to Fannie & Freddie – especially right at the end, when the
Street was desperate for high credit quality product to fluff their securities
prospectuses. I do remember specifically a day that my client called me
and told me that the Street was bidding up for regular Agency product – not the
affordable subprime stuff – and it was more than FNMA/ FHLMC was paying. 
I sensed there was something fishy at the time, but I had no idea. That
was February 2007, 3 months before the first “no bid” because there was no
market for a Subprime pool in May. It’s convenient for certain political
leaning groups to blame the Agencies (government), just like it’s convenient
for other political leaning groups to blame the banks.  Both are wrong,
and both are right.”

And a
mortgage bank owner from Oregon wrote, “In reality it was the indirect effects
of Fannie and Freddie policy goals that greatly influenced some of the worst
decisions the banks and investment companies made.  One example was that
by 2002 the GSEs mandated a goal of 50% of all home loans made by lenders had
to be made to low and subprime borrows.  These are loans that in the best
of times would have made up approx. 15% of the loan pool.  So to stay
compliant lenders especially banks were making loans they did not want on their
books thus the tremendous expansion of securitization, CDO’s.”

And now
the agencies, and investors in mortgage-backed securities, are grappling with
the prospect of principal reductions. Edward DeMarco, the temporary director of
the Federal Housing Finance Agency, continues to endure blistering criticism
for refusing to allow Fannie and Freddie to pay for large-scale principal
reductions
for underwater borrowers or to facilitate refinancings for those
stuck with high interest rate mortgages.  More

Though
officials are mum on specifics, the FHA is
readying changes to its controversial condominium rules
that have rendered
large numbers of units ineligible for low down-payment insured mortgages: .

I have
heard dozens of stories about Fannie & Freddie requesting lenders buyback
loans for reasons that are not material, and/or did not impact the borrower’s
failure to make payments. But in listening to the agencies, this is not the
case. It is almost as if the sales & management staff work for entirely
different organizations from the auditing and QC departments of the agencies,
which continue to be well funded and staffed.  Fannie Mae’s annual and quarterly SEC reports
filed on May 9 included extensive discussion of loan repurchase activity. As of March 31, 2012, Fannie Mae’s
repurchase requests increased to $12.15 billion, which is significantly higher
than the $8.65 billion it requested at the same point last year.

Two other
statistics stand out in the filing:  the total amount of cancelled
repurchase requests and the amount resolved in ways other than a full
repurchase. The first quarter of 2012 saw Fannie Mae cancel $337 million in
repurchase requests compared to $227 million over the same period last year. In
other words, Fannie Mae cancelled more than half-a-billion dollars in repurchases
in just two of the past five quarters. Additionally, during the first quarter
of 2012 more than $2.1 billion in repurchase requests were resolved through
methods other than a full repurchase, out of $4.47 billion in total resolutions
(i.e. almost 55 percent). These alternative methods include loan pricing
adjustments, lender corrective action, and negotiated settlements. 
Because Fannie Mae reported the face value of the repurchased loan, not the
amount of recovery, it is difficult to analyze the effectiveness of such
alternatives. But I hear from the owner of a mid-sized mortgage bank: “Even if the agencies throw 10 loans at us
to buyback, and we win on all 10 because the logic was flawed or they missed
something in the file, we still have to dedicate the resources to win on those
10 – we’re being worn down.”

Fannie Mae made clear its ongoing intent to “aggressively pursue” repurchase
requests, citing the possible need to draw more funds from the Treasury if
lenders do not comply with its demands.  Fannie Mae reportedly perceives
increased exposure to the institutional risks associated with smaller and
non-traditional origination sources because of the reduction in correspondent
lenders and mortgage brokers; the filings reflect a conservative valuation of
the outstanding repurchase requests to these seller/servicers. This may lessen
the incentive for Fannie Mae to collect relative to requests to the largest
seller/servicers, as the loss will have already been realized on its books.

This seems to indicate that Fannie Mae may focus on collecting the outstanding
requests from its 10 largest customers, who currently account for 74% of the
company’s single-family book of business. However, as repurchase requests
increase the amount of alternative resolutions and outright cancellations will
increase proportionally. Either way, the
trickle-down practice is in full effect
– if anyone thinks that the large
aggregators will absorb the losses and spare the smaller lenders, I have a
subprime security I’d like to sell them.

In a related topic, one of the big
fears of lenders, and servicers, in doing the HARP II loans is mechanical
failure.
Not the kind
where the landing gear doesn’t come down, although that would be a decent
analogy, but where the borrower doesn’t use the same initials on page 37 of the
disclosure package, or someone forgot to check the “manufactured
home” box during processing. And the loan goes bad. Operational risk has replaced credit risk as the major safety and
soundness challenge for national banks
, U.S. Comptroller Thomas Curry said in
a recent speech. Curry said operational risk, or the risk of loss due to
failures of people, processes, systems and external events, is “high and
increasing” in light of the complexity of today’s banking markets and the
technology that supports it. Curry said operational risk is currently at the
top of the list of safety and soundness issues for the institutions the OCC supervises.
An article in American Banker noted
that Curry said operational risks manifest in a number of ways, from inadequate
systems and controls that led to servicing mortgage servicing errors, to flawed
risk models that create inadequate risk management systems, to lack of controls
over relationships with third-party vendors. In particular, Curry said the OCC
is finding a rising number of Bank Secrecy Act and anti-money laundering
deficiencies in midsize and community banks, including ineffective account
monitoring, inadequate tracking of high-risk customers and bulk cash
transactions, and lapses in monitoring suspicious activity.
 
The good news, however, is that the turmoil in Europe has been positive for US
mortgage rates for two main reasons. First, economic growth in the region has
slowed, which reduces future inflationary pressures. In addition, investors
have responded to the uncertainty by shifting to relatively safer assets,
including US mortgage-backed securities (MBS). It seems that the only groups
complaining about rates are the investors who bought 30-yr mortgages with
coupons above 4.5%, or servicers with a lot of this product on their books. (Of
course, the hedge against servicing runoff is new production.)

On no
news, yesterday’s 10-yr T-note closed at 1.74%. With the press still yammering about
Facebook’s IPO performance, 10AM EST gives us April’s Existing Home Sales
(4.62M vs. 4.48M last) and May’s Richmond Fed Manufacturing index (+11 against
+14 prior); at 1PM EST we’ll have the Treasury’s $35 billion 2-yr note auction.
Unfortunately for anyone waiting to lock
yesterday, the 10-yr is up to 1.79% and MBS prices are worse .125-.250
.

[Into each
life a little vacation must fall.
Yesterday was spent driving across Nevada and spending the night at the “luxurious”
Rustic Inn in Ely, on the way to Moab, Utah for some camping and mountain bike
riding in an area with no internet – if that still exists. A few folks are
lined up to write, however, at end of the week. Just don’t look for many
e-mails after tomorrow.]

Several weeks ago the commentary had a fictional story about the evolution of a
word using the initials from “Stack High in Transit.” It turns out
there is a banking tie-in when I received this note:
“My brother receives your commentary and was telling me of his own ‘Stack
High In Transit’ story.t
He worked for a local community bank many years ago where occasionally a loan
application would come back from loan committee rejected and marked
“NFW”.
The compliance officer of the bank hated to see that noted, of course, until my
brother told him to think of it as, “No Financial Wherewithal” versus
what we all know it meant.

…(read more)

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