REQUIRED READING: Since 2008, housing finance and federal policies have been totally intertwined. The result: More than 95% of all originations and virtually all of the residential mortgage-backed securities (RMBS) issuance, with the exception of a handful of Redwood Trust offerings and other deals, have been backed by the U.S. Department of the Treasury and taxpayers. By the end of this year, our industry may have a better sense of what kind of role private capital can and will play going forward, and how soon this can occur.
Having said that, there are a number of policy changes, big and small, currently being considered which could expedite or impede the return of private capital. Some, like the new qualified mortgage (QM) and qualified residential mortgage (QRM) definitions, will also potentially affect the availability of credit and the future of private label securitization. Others, like the new proposed Basel III rules, could potentially reshape the servicing industry by making it even less attractive to large banks and creating new opportunities for investors that are able to hold mortgage servicing rights (MSRs) to the extent that the agencies accept new market entrants.
Certainly the biggest unknown facing the secondary market is the fate of Fannie Mae and Freddie Mac. While the agencies will be modified at some point in the future, the likelihood of that happening over the next four years is still relatively low.
In August, the Treasury changed the terms of its support for the government-sponsored enterprises (GSEs), requiring them to repatriate all profits, not just a 10% dividend, to repay the bailout. It also ordered them to continue shrinking the size of their portfolios until they are whittled down to $250 billion. However, the GSEs don't have to be at that level until 2018.
Why will this take so long? First, it will require congressional action, which most likely will not be a priority for either party. In fact, most observers predict the earliest that the process would begin would be mid-to-late 2013. And then, of course, there is no bipartisan consensus on what would replace them. This is not an insignificant decision, given the GSEs are currently guaranteeing approximately 70% of the new origination market and are the primary relief agencies dealing with the foreclosure crisis.
Replacing critical infrastructure without causing major disruption requires careful planning and can be time consuming. As an analogy, think about the San Francisco-Oakland Bay Bridge Project. For years, a new and more structurally sound bridge has been being built approximately 80 yards from the current one. Like the bridge, a new GSE structure must be built with consideration for its predecessor before the old one can be dismantled.
Moreover, the recent upturn in the housing market, and the GSEs' swing to profitability, may take some of the urgency out of the efforts to dismantle them as well. However, there are steps that can be taken now, without congressional action, which could send a positive signal to the marketplace.
The GSE loan limits, for example, could be lowered again to bring them closer to their pre-crisis levels. This would immediately create more room in the market for jumbo lenders and increase the amount of nonconforming product that eventually would be available for private label deals.
Similarly, the Federal Housing Administration (FHA) ceilings, which are currently higher than the GSEs, could be lowered. This would reduce that agency's market share and risk exposure. In addition, lower loan ceilings and further risk-based price adjustments for FHA insurance would also create more opportunity for the struggling mortgage insurance industry to write its way back to profitability. Keep in mind the mortgage insurance industry is one of the few examples of private capital at risk in housing finance.
Finally, the agencies could accelerate their plan to issue non-guaranteed agency securities. This would give the private market a better idea of the appetite for non-guaranteed RMBS.
From QM to Catch-22
In the very near future, the Consumer Finance Protection Bureau (CFPB) is expected to issue its final QM rule. How that rule is written will send a strong message to our industry. By now, most readers know the big issue: Will there be a ‘safe harbor’ provision that would provide an objective definition of a QM or a more subjective standard: ‘rebuttable presumption of compliance?’
Both the Mortgage Bankers Association and the Asset Securitization Forum have consistently argued that only the former will give originators and investors the protection they will need to expand credit in the future.
Recently, Amherst Capital came out with an eye-opening report on QM and how it could unintentionally further exacerbate the contraction of credit from all but the most pristine borrowers. What's the worst-case scenario for both industry and borrowers in general? According to Amherst, it's QM with no safe harbor, QRM defined along the lines originally proposed by CFPB and a strict interpretation of high-cost loans.
Here's how this might play out: Only the least-risky loans would be originated and securitized, and non-QM and non-QRM securities (if any) would have to have much higher fees and rates to justify the risk of non-compliance and long-tail lawsuits.
Making these higher cost loans and rejecting non-QM candidates, Amherst said, might expose participants to the Home Ownership and Equity Protection Act's high-cost threshold violations and discrimination suits based on ‘disparate impact.’ So, in addition to reading all the new regulations, it looks like our industry may also be re-reading ‘Catch-22.’
And as if that wasn't enough, the Federal Reserve and various banking regulators came out with their latest proposals for Basel III during the summer. From our industry's perspective, one of the biggest changes has to do with how MSRs are applied to banks' Tier-one Capital. As soon as January 2013, MSRs will be counted toward 10% of a bank's required capital, down from the current 50%. This will certainly make servicing a less attractive business for many large lenders.
Ironically, this is occurring at a time when the quality of loans is at an all-time high, and the interest rates (and with them, pre-payment speeds) will be at an all-time low. Some large banks, such as Bank of America and J.P. Morgan, have already announced or executed MSR sales. Some observers have estimated that as much as $4 trillion in MSRs could change hands over the next few years.
The question is this: ho does want to be in the servicing business? Certainly, some large investors are interested in MSRs at the right price, particularly for recent (read: post-2009) vintage loans, which are extremely high quality. Will they be in the business for the long run, particularly if they have to meet the new servicing standards that surely will migrate from regulated servicers to all servicers in the future?
Today, the average mortgage originator has to comply with an array of federal, state and sometimes county and municipal laws, depending on where the loan is made. And that's before CFPB comes out with its new overarching rules, like the ‘abusive practices’ standard that is still being developed for the mortgage industry – which could significantly expand compliance risks.Â Â Â
Meanwhile, servicers could conceivably have to comply with the U.S. Department of Justice consent order, as well as new standards being promulgated by the CFPB, to say nothing of the requirements of their pooling and servicer agreements with investors. Also, many regulated institutions are still looking for direction from their regulators.
The wave of new regulations, combined with the risk of put-backs and lawsuits, has prompted some companies to exit the mortgage business and others to re-think what parts they want to be in. Several large lenders have already closed their correspondent and wholesale operations.
Given the products and practices that led to the mortgage crisis, the onslaught of regulation was entirely predictable and, to a certain extent, warranted. But has the pendulum swung too far?Â Many of the new rules being issued focus on products that do not exist in today's market and practices that investors will no longer tolerate. The question remains: Are we fighting the last war, and, if so, will new policies signal either an escalation or a much-needed truce?
Tom Donatacci is executive vice president of business development of Shelton, Conn.-based Clayton Holdings LLC. He can be reached at (877) 291-5301.