Tag Archives: jumbo

Easy Money From Fannie Mae

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The San Francisco Chronicle quoted me in Fannie Mae Making It Easier to Spend Half Your Income on Debt. It reads in part,

Fannie Mae is making it easier for some borrowers to spend up to half of their monthly pretax income on mortgage and other debt payments. But just because they can doesn’t mean they should.

“Generally, it’s a pretty poor idea,” said Holly Gillian Kindel, an adviser with Mosaic Financial Partners. “It flies in the face of common financial wisdom and best practices.”

Fannie is a government agency that can buy or insure mortgages that meet its underwriting criteria. Effective July 29, its automated underwriting software will approve loans with debt-to-income ratios as high as 50 percent without “additional compensating factors.” The current limit is 45 percent.

Fannie has been approving borrowers with ratios between 45 and 50 percent if they had compensating factors, such as a down payment of least 20 percent and at least 12 months worth of “reserves” in bank and investment accounts. Its updated software will not require those compensating factors.

Fannie made the decision after analyzing many years of payment history on loans between 45 and 50 percent. It said the change will increase the percentage of loans it approves, but it would not say by how much.

That doesn’t mean every Fannie-backed loan can go up 50 percent. Borrowers still must have the right combination of loan-to-value ratio, credit history, reserves and other factors. In a statement, Fannie said the change is “consistent with our commitment to sustainable homeownership and with the safe and sound operation of our business.”

Before the mortgage meltdown, Fannie was approving loans with even higher debt ratios. But 50 percent of pretax income is still a lot to spend on housing and other debt.

The U.S. Census Bureau says households that spend at least 30 percent of their income on housing are “cost-burdened” and those that spend 50 percent or more are “severely cost burdened.”

The Dodd-Frank Act, designed to prevent another financial crisis, authorized the creation of a “qualified mortgage.” These mortgages can’t have certain risky features, such as interest-only payments, terms longer than 30 years or debt-to-income ratios higher than 43 percent. The Consumer Financial Protection Bureau said a 43 percent limit would “protect consumers” and “generally safeguard affordability.”

However, loans that are eligible for purchase by Fannie Mae and other government agencies are deemed qualified mortgages, even if they allow ratios higher than 43 percent. Freddie Mac, Fannie’s smaller sibling, has been backing loans with ratios up to 50 percent without compensating factors since 2011. The Federal Housing Administration approves loans with ratios up to 57 percent, said Ed Pinto of the American Enterprise Institute Center on Housing Risk.

Since 2014, lenders that make qualified mortgages can’t be sued if they go bad, so most lenders have essentially stopped making non-qualified mortgages.

Lenders are reluctant to make jumbo loans with ratios higher than 43 percent because they would not get the legal protection afforded qualified mortgages. Jumbos are loans that are too big to be purchased by Fannie and Freddie. Their limit in most parts of the Bay Area is $636,150 for one-unit homes.

Fannie’s move comes at a time when consumer debt is soaring. Credit card debt surpassed $1 trillion in December for the first time since the recession and now stands behind auto loans ($1.1 trillion) and student loans ($1.4 trillion), according to the Federal Reserve.

That’s making it harder for people to get or refinance a mortgage. In April, Fannie announced three small steps it was taking to make it easier for people with education loans to get a mortgage.

Some consumer groups are happy to see Fannie raising its debt limit to 50 percent. “I think there are enough other standards built into the Fannie Mae underwriting system where this is not going to lead to predatory loans,” said Geoff Walsh, a staff attorney with the National Consumer Law Center.

Mike Calhoun, president of the Center for Responsible Lending, said, “There are households that can afford these loans, including moderate-income households.” When they are carefully underwritten and fully documented “they can perform at that level.” He pointed out that a lot of tenants are managing to pay at least 50 percent of income on rent.

A new study from the Joint Center for Housing Studies at Harvard University noted that 10 percent of homeowners and 25.5 percent of renters are spending at least 50 percent of their income on housing.

When Fannie calculates debt-to-income ratios, it starts with the monthly payment on the new loan (including principal, interest, property tax, homeowners association dues, homeowners insurance and private mortgage insurance). Then it adds the monthly payment on credit cards (minimum payment due), auto, student and other loans and alimony.

It divides this total debt by total monthly income. It will consider a wide range of income that is stable and verifiable including wages, bonuses, commissions, pensions, investments, alimony, disability, unemployment and public assistance.

Fannie figures a creditworthy borrower with $10,000 in monthly income could spend up to $5,000 on mortgage and debt payments. Not everyone agrees.

“If you have a debt ratio that high, the last thing you should be doing is buying a house. You are stretching yourself way too thin,” said Greg McBride, chief financial analyst with Bankrate.com.

*     *     *

“If this is data-driven as Fannie says, I guess it’s OK,” said David Reiss, who teaches real estate finance at Brooklyn Law School. “People can make decisions themselves. We have these rules for the median person. A lot of immigrant families have no problem spending 60 or 70 percent (of income) on housing. They have cousins living there, they rent out a room.”

Reiss added that homeownership rates are low and expanding them “seems reasonable.” But making credit looser “will probably drive up housing prices.”

The article condensed my comments, but they do reflect the fact that the credit box is too tight and that there is room to loosen it up a bit. The Qualified Mortgage and Ability-to-Repay rules promote the 43% debt-to-income ratio because they provide good guidance for “traditional” nuclear American families.  But there are American households where multigenerational living is the norm, as is the case with many families of recent immigrants. These households may have income streams which are not reflected in the mortgage application.

Can Fannie and Freddie Be Privatized?

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Kroll Bond Rating Agency posted Housing Reform 2017: Can the GSEs be Privatized? The big housing finance reform question is whether there is now sufficient consensus in Washington to determine the fate of Fannie and Freddie, now approaching their ninth year in conservatorship.

Kroll concludes,

The Mortgage Bankers Association sends a very clear message about privatizing the GSEs: It will raise rates for homeowners and add systemic risk back into the financial system. Why do we need to fix a proven market mechanism that is not broken? KBRA believes that if Mr. Mnuchin and the President-elect truly want to encourage the growth of a private market for U.S. mortgages, then they must accept that true privatization of the GSEs that eliminates any government guarantee would fundamentally change the mortgage market.

The privatization of the GSEs implies, in the short term at least, a significant decrease in the financing available to the U.S. housing market. In the absence of a TBA market, no coupon would be high enough to support the entire range of demand for mortgage finance, only pockets of higher quality loans as with the jumbo mortgage market today. Unless the U.S. moved to the Danish model with 100% variable rate notes, no nonbank could fund the production of home mortgages efficiently and commercial banks are unlikely to pick up the slack for the reasons discussed above.

In the event of full privatization of the GSEs, private loans will have significantly higher cost for consumers and offer equally more attractive returns for financial institutions and end investors, a result that would generate enormous political opposition among the numerous constituencies in the housing market. Needless to say, getting such a proposal through Congress should prove to be quite an achievement indeed. (4)

I disagree with Kroll’s framing of the issue:  “Why do we need to fix a proven market mechanism that is not broken?” To describe Fannie and Freddie as “not broken” seems farcical to me. They are in a state of limbo with extraordinary backing from the federal government. It might be that we would want to continue them with much the same functionality that they currently have, but we would still want this transition to be done intentionally.  Nobody, but nobody, was thinking that putting them into conservatorship was the end game,

While the current structure has some advantages over privatization, the reverse is true too.  The greatest benefit of privatization is getting rid of the taxpayer backstop in case of a failure by one or both of the companies.

We shouldn’t be saying — hey, what we have now is good enough. Rather, we should be asking — what do we expect out of our housing finance system and how do we get it?

There appears to be a broad consensus to reduce taxpayer exposure to a bailout.  There also appears to be a broad consensus (one that I do not support as broadly as others) to protect the 30 year fixed rate mortgage that remains so popular in the United States.

Industry insiders believe that a fully private system would not provide sufficient capital for the mortgage market. They are also concerned that a fully private system would put the kibosh on the To Be Announced (TBA) market that provides so much stability for the mortgage origination process.

A thoughtful reform proposal could incorporate all of these concerns while also clearing away the sticky problems built into the Fannie/Freddie model of housing finance.

“If it ain’t broke don’t fix it” is not a good enough philosophy after we have lived through the financial crisis. We should focus on the big questions of what we want from our 21st century housing finance system and then design a system that will implement it accordingly.

The Jumbo/Conforming Spread

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Standard & Poor’s issued a research report, What Drives the Variation Between Conforming and Jumbo Mortgage Rates? It opens,

What drives the variation between the conforming and jumbo mortgage rates for the 30-year fixed-rate mortgage (FRM) product offered in the U.S. residential housing market? While credit and interest rate risk are the main factors at play, S&P Global Ratings explores how these risks relate to capital market execution and whether this relationship translates into additional liquidity risk. In our study, we compare the historical spreads between the two average note rates over time, and we also examine the impact of certain loan credit characteristics. Our data indicate that the rate difference grows in periods for which the opportunity for securitization declines as a viable exit strategy for lenders. (1)

S&P also finds that “[r]isk-based pricing trends also appear to influence the jumbo-conforming spread” and that “[t]he currently narrow spread suggests that a combination of g-fee increases and jumbo credit migration has, to some extent, counteracted the lack of liquidity in the non-agency market.” (1)

The report offers some concise background:

The 30-year FRM is a product unique to the U.S. residential housing market. Lenders in other countries typically offer adjustable-rate or balloon mortgages, which serve as the primary debt tools for housing finance. The 30-year FRM has not been globally adopted, partially because the long-term amortization schedule can saddle a lender with substantial interest rate risk in addition to potentially prolonged credit risk. However, the structure of the mortgage financing system in the U.S. provides an exit strategy: lenders can typically sell loan pools into a reasonably deep market if they are averse to the credit, duration, or convexity risks posed by these long-term assets.

In the U.S., the majority of mortgage financing is channeled through government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which have a mandate to buy mortgages for their own portfolios and securitize loan pools, which are subsequently sold to investors. Mortgages that are not financed via the GSEs are often either securitized in the non-agency market or held in institutional portfolios. Both agency and non-agency securitizations optimize funding sources and liquidity, thereby allowing homeowners to enjoy relatively low mortgage rates across the U.S. (1)

My main takeaways from the report are that (1) the decrease in securitization since the financial crisis has contributed to a wider spread between jumbo and conforming mortgages; (2) the high guaranty fee for conforming mortgages pushes down the spread between jumbo and conforming mortgages; and (3) the credit box appears to be loosening a bit, which should mean that jumbos will become available to more than the “super-prime” slice of the market.

Mortgage Market Forecast

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OnCourseLearning.com’s new financial services blog quoted me in Mortgage Rates Likely to Remain Low for Foreseeable Future. It opens,

In the weeks since the United Kingdom voted to leave the European Union, previously low interest rates have fallen to near historically low levels.

For the week ending Aug. 25, a 30-year fixed rate mortgage averaged 3.43%, just slightly above the record low of 3.31% established in 2012. At the same time a year ago, the average mortgage rate for a 30-year fixed rate mortgage was 3.84%, according to Freddie Mac.

The drop in interest rates appears to be drawing more homeowners into the mortgage market. Freddie Mac now expects 2016 loan originations to reach $2 trillion, the highest level since 2012.

Market Uncertainty

While markets have calmed since the Brexit vote in late June, the Mortgage Bankers Association cautioned in a July 14 Economic and Mortgage Finance commentary that the actual “terms and conditions of the exit will continue to destabilize markets.”

Global economic uncertainty, oil price fluctuations, slow economic growth and the potential for interest rate hikes suggest market instability will likely continue for some time, experts said. As a result, most analysts expect interest rates will remain low, at least in the short term.

“Those who have been betting on increasing interest rates have been wrong for a long time now,” said David Reiss, professor of law at Brooklyn Law School and research director of its Center for Urban Business Entrepreneurship. He believes rates likely will remain low “over the next six to 12 months, partially driven by a further reduction in spreads between Treasury yields and mortgage rates.”

Greg McBride, chief financial analyst for Bankrate.com, a personal finance website, expects “the backdrop of slow global economic growth, low inflation, and negative interest rates elsewhere will keep demand for U.S. bonds high, and mortgage rates [below] 4% in the foreseeable future.”

In July, Freddie Mac predicted the 30-year rate won’t top 3.6% in 2016, or 4% in 2017.

Lending Opportunities

The low-interest rates have created new opportunities for lenders. Refinance bids recently reached their highest level in three years.

“With mortgage rates having been range-bound for so long, this breakout to the low side has opened the door to refinancing for homeowners who had previously refinanced around 4% or even just below,” McBride said. He expects refinancing demand to continue as long as mortgage rates stay close to 3.5%, but predicts rates may need to drop a bit more to prolong the boom.

Meanwhile, rising home prices are creating more equity, and the MBA expects homeowners to want more cash-out refinancing. In its July 14 report, the MBA raised its 2016 refinance origination forecasts by 10% to $760 billion, replacing its pre-Brexit projection of a decrease.

As rates fall, refinancing becomes attractive earlier for those with outsize mortgages. These jumbo loans are those that exceed $417,000 in most of the country, or $625,000 in high-priced markets like New York and San Francisco, according to a July 7 online article in the Wall Street Journal. With these big loans, lower rates can mean substantial savings.

“Borrowers with larger loans stand to gain more by refinancing, and may not need as large of a rate incentive than borrowers with lower loan balances,” according to the July 14 MBA report. Because more affluent borrowers take out these loans, they generally have fewer delinquencies or foreclosures, and lenders can steer big borrowers to a bank’s other accounts and services. They’re also becoming cheaper: Rates on jumbo loans were at record lows in July, according to the MBA.

Reiss thinks lenders have been somewhat “slow to expand in the jumbo market, and may now gain a leg up over their competitors by doing so.”

Potential Risks

Still, lenders face some risks to profitability, including increased regulatory expenses such as the impact of the Consumer Financial Protection Bureau’s new TRID rule. Most of the pain from the TRID regulations, Reiss said, involve “transition costs for implementing the new regulation, and those costs will decrease over time.”

The End of Private-Label Securities?

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Steve Jurvetson

Jamie Dimon, CEO of JPMorgan Chase

J.P. Morgan’s Securitized Products Weekly has a report, Proposed FRTB Ruling Endangers ABS, CMBS and Non-Agency RMBS Markets. This is one of those technical studies that have a lot of real world relevance to those of us concerned about the housing markets more generally.

The report analyzes proposed capital rules contained in the Fundamental Review of the Trading Book (FRTB). JPMorgan believes that these proposed rules would make the secondary trading in residential mortgage-backed securities unprofitable. It also believes that “there is no sector that escapes unscathed; capital will rise dramatically across all securitized product sectors, except agency MBS.” (1) It concludes that “[u]ltimately, in its current form, the FRTB would damage the availability of credit to consumers, reduce lending activity in the form of commercial mortgage and set back private securitization, entrenching the GSEs as the primary securitization vehicle in the residential mortgage market.” (1)

JPMorgan finds that the the impact of these proposed regulations on non-agency residential-mortgage backed securities (jumbos and otherwise) “is so onerous that we wonder if this was the actual intent of the regulators.” Without getting too technical, the authors thought “that the regulators simply had a mathematical mistake in their calculation (and were off by a factor of 100, but unfortunately this is what was intended.” (4) Because these capital rules “would make it highly unattractive for dealers to hold inventory in non-agency securities,” JPMorgan believes that they threaten the entire non-agency RMBS market. (5)

The report concludes with a policy takeaway:

Policymakers have at various times advocated for GSE reform in which the private sector (and private capital) would play a larger role. However, with such high capital requirements under the proposal — compared with capital advantages for GSE securities and a negligible amount of capital for the GSEs themselves — we believe this proposal would significantly set back private securitization, entrenching the GSEs as the primary securitization vehicle in the mortgage market. (5, emphasis removed)

I am not aware if JPMorgan’s concerns are broadly held, so it would important to hear others weigh in on this topic.

If the proposed rule is adopted, it is likely not to be implemented for a few years.  As a result, there is plenty of time to get the right balance between safety and soundness on the one hand and credit availability on the other. While the private-label sector has been a source of trouble in the past, particularly during the subprime boom, it is not in the public interest to put an end to it:  it has provided capital to the jumbo sector and provides much needed competition to Fannie, Freddie and Ginnie.

S&P on Jumbos

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Last week, I discussed an up beat S&P report on the overall RMBS market. Today I discuss and S&P report on the jumbo mortgage market. This report sees much slower growth in the private-label jumbo residential mortgage-backed securities market. It opens,

U.S. housing has been recovering, and residential mortgage collateral performance continues to improve, a trend that we expect to continue in 2015. However, housing finance still faces challenges and relies on government support. Private capital has been slow to reenter the residential mortgage market, and nonagency securitization volume remains relatively small, with diversity and growth mostly coming from nontraditional transactions in recent years. Standard & Poor’s Ratings Services believes nonagency securitization—-utilizing private capital–could be a key contributor to a more healthy housing finance market while limiting risk to taxpayers.

A revival in the U.S. nonagency residential mortgage-backed securities (RMBS) market has not followed measured recoveries in the broader economy, employment, and housing. RMBS not guaranteed by one of the government-sponsored enterprises (GSEs)–such as Fannie Mae or Freddie Mac–hit a high of $1.2 trillion in 2006, but we expect that figure to be near $50 billion in 2015, up approximately $12 billion from 2014. Clearly, even with the ongoing recoveries in the overall economy and housing market, nonagency U.S. RMBS-related issuance remains negligible in the $10 trillion housing finance market.

We believe the slow pace of non-agency securitization reflects a market still grappling with the changing economics of complying with new regulations, a lack of standardization in nonagency securitization provisions, anticipated interest rate hikes in mid-2015, and a cautious investor base in newly originated nonagency RMBS. Considerable clarity has emerged regarding new regulations this year, but other limiting factors persist.

Hopefully, S&P has correct identified the cause of the slow growth in this sector. But we need to be vigilant to ensure that there is not a more fundamental problem with the jumbo private-label MBS market. it is vital that this sector of the market develops in order to provide a private capital alternative to the existing market which depends to a very large extent on government guarantees.

Frannie Effects on Mortgage Terms

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The Federal Reserve’s Alex Kaufman has posted The Influence of Fannie and Freddie on Mortgage Loan Terms to SSRN.  It is behind a paywall on SSRN, but an earlier draft is available elsewhere on the web. The abstract reads,

This article uses a novel instrumental variables approach to quantify the effect that government‐sponsored enterprise (GSE) purchase eligibility had on equilibrium mortgage loan terms in the period from 2003 to 2007. The technique is designed to eliminate sources of bias that may have affected previous studies. GSE eligibility appears to have lowered interest rates by about ten basis points, encouraged fixed‐rate loans over ARMs and discouraged low documentation and brokered loans. There is no measurable effect on loan performance or on the prevalence of certain types of “exotic” mortgages. The overall picture suggests that GSE purchases had only a modest impact on loan terms during this period.

This is pretty dry reading, but it is actually an important project: “[g]iven the GSEs’ vast scale, the liability they represent to taxpayers, and the decisions that must soon be made about their future, it is crucial to understand how exactly they affect the mortgage markets in which they operate.” (2, earlier draft) The current conventional wisdom is that the two companies will return in something that looks like their pre-conservatorship form.

Given that that is the case, studies such as these are useful for providing some facts about the actual impact that these two companies actually have on the mortgage market.  In terms of their impact on loan terms, it appears that the two companies have a modest or even “mixed” effect, at least for the subset of mortgages studied. (22, earlier draft) And there “is no measurable effect on loan performance” at all. (22, earlier draft)

I have argued previously that returning Fannie and Freddie to their pre-conservatorship ways is a bad call. I still think that is the case. And I think studies such as these offer support for that view, in the face of the conventional wisdom.