Tag Archives: mortgage market

Rising Rates and The Mortgage Market

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The Urban Institute’s Housing Finance at a Glance Chartbook for March focuses on how rising interest rates have been impacting the mortgage market. The chartbook makes a series of excellent points about current trends, although homeowners and homebuyers should keep in mind that rates remain near historic lows:

As mortgage rates have increased, there has been no shortage of articles explaining the effect of rising rates on the mortgage market. Mortgage rates began their present sustained increase immediately after the last presidential election in November 2016, 20 months ago. Enough data points have become available during thisperiod that we can now measure the effects of rising rates. Below we outline a few.

Refinances: The most immediate impact of rising rates is on refinance volumes, which fall as rates rise. For mortgages backed by Fannie Mae and Freddie Mac, the refinance share of total originations declined from 63 percent in Nov 2016 to 46 percent today (page 11). For FHA, VA and USDA-insured mortgages, the refinance share dropped from 44 percent to 35 percent. In terms of volume, Fannie Mae and Freddie Mac backed refinance volume totaled $390 billion in 2017, down from $550 billion in 2016. For Ginnie Mae, refi volume dropped from $197 billion in 2016 to $136 billion in 2017. Looking ahead, most estimates for 2018 point to a continued reduction in the refi share and origination volumes (page 15).

Originator profitability: Of course, less demand for mortgages isn’t good for originator profitability because lenders need to compete harder to attract borrowers. They do this often by reducing profit margins as rates rise (conversely, when rates are falling and everyone is rushing to refinance, lenders tend to respond by increasing their profit margins). Indeed, since Nov 2016, originator profitability has declined from $2.6 per $100 of loans originated to $1.93 today (page 16). Post crisis originator profitability reached as high as $5 per $100 loan in late 2012, when rates were at their lowest point.

Cash-out share: Another consequence of falling refinance volumes is the rising share of cash-out refinances. The share of cash-out refinances varies partly because borrowers’ motivations change with interest rates. When rates are low, the primary goal of refinancing is to reduce the monthly payment. Cash-out share tends to be low during such periods. But when rates are high, borrowers have no incentive to refinance for rate reasons. Those who still refinance tend to be driven more by their desire to cash-out (although this doesn’t mean that the volume is also high). As such, cash-out share of refinances increased to 63 percent in Q4 2017 according to Freddie Mac Quarterly Refinance Statistics. The last time cash-out share was this high was in 2008.

Industry consolidation: A longer-term impact of rising rates is industry consolidation: not every lender can afford to cut profitability. Larger, diversified originators are more able to accept lower margins because they can make up for it through other lines of business or simply accept lower profitability for some time. Smaller lenders may not have such flexibility and may find it necessary to merge with another entity. Industry consolidation due to higher rates is not easy to quantify as firms can merge or get acquired for various reasons. At the same time, one can’t ignore New Residential Investment’s recent acquisition of Shellpoint Partners and Ocwen’s purchase of PHH. (5)

FinTech Disrupting The Mortgage Industry

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photo by www.cafecredit.com

photo by www.cafecredit.com

Researchers at the NY Fed have posted The Role of Technology in Mortgage Lending. There is no doubt that tech can disrupt the mortgage lending business much as it has done with others. The abstract reads,

Technology-based (“FinTech”) lenders increased their market share of U.S. mortgage lending from 2 percent to 8 percent from 2010 to 2016. Using market-wide, loan-level data on U.S. mortgage applications and originations, we show that FinTech lenders process mortgage applications about 20 percent faster than other lenders, even when controlling for detailed loan, borrower, and geographic observables. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks, thereby alleviating capacity constraints associated with traditional mortgage lending. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target marginal borrowers. Our results suggest that technological innovation has improved the efficiency of financial intermediation in the U.S. mortgage market.

The report documents the significant extent to which FinTech firms have already disrupted the primary mortgage market. They also predict a whole lot more disruption coming down the pike:

Going forward, we expect that other lenders will seek to replicate the “FinTech model” characterized by electronic application processes with centralized, semi-automated underwriting operations. However, it is unclear whether traditional lenders or small institutions will all be able to adopt these practices as these innovations require significant reorganization and sizable investments. The end result could be a more concentrated mortgage market dominated by those firms that can afford to innovate. From a consumer perspective, we believe our results shed light on how mortgage credit supply is likely to evolve in the future. Specifically, technology will allow the origination process to be faster and to more easily accommodate changes in interest rates, leading to greater transmission of monetary policy to households via the mortgage market. Our findings also imply that technological diffusion may reduce inefficiencies in refinancing decisions, with significant benefits to U.S. households.

Our results have to be considered in the prevailing institutional context of the U.S. mortgage market. Specifically, at the time of our study FinTech lenders are non-banks that securitize their mortgages and do not take deposits. It remains to be seen whether we find the same benefits of FinTech lending as the model spreads to deposit-taking banks and their borrowers. Changes in banking regulation or the housing finance system may affect FinTech lenders going forward. Also, the benefits we document stem from innovations that rely on hard information; as these innovations spread, they may affect access to credit for those borrowers with applications that require soft information or borrowers that require direct communication with a loan officer. (37-38)

I think that the author’s predictions are right on target.

 

Mortgage Insurers and The Next Housing Crisis

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photo by Jeff Turner

The Inspector General of the Federal Housing Finance Agency has released a white paper on Enterprise Counterparties: Mortgage Insurers. The Executive Summary reads,

Fannie Mae and Freddie Mac (the Enterprises) operate under congressional charters to provide liquidity, stability, and affordability to the mortgage market. Those charters, which have been amended from time to time, authorize the Enterprises to purchase residential mortgages and codify an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families. Pursuant to their charters, the Enterprises may purchase single-family residential mortgages with loan-to-value (LTV) ratios above 80%, provided that these mortgages are supported by one of several credit enhancements identified in their charters. A credit enhancement is a method or tool to reduce the risk of extending credit to a borrower; mortgage insurance is one such method. Since 1957, private mortgage insurers have assumed an ever-increasing role in providing credit enhancements and they now insure “the vast majority of loans over 80% LTV purchased by the” Enterprises. In congressional testimony in 2015, Director Watt emphasized that mortgage insurance is critical to the Enterprises’ efforts to provide increased housing access for lower-wealth borrowers through 97% LTV loans.

During the financial crisis, some mortgage insurers faced severe financial difficulties due to the precipitous drop in housing prices and increased defaults that required the insurers to pay more claims. State regulators placed three mortgage insurers into “run-off,” prohibiting them from writing new insurance, but allowing them to continue collecting renewal premiums and processing claims on existing business. Some mortgage insurers rescinded coverage on more loans, canceling the policies and returning the premiums.  Currently, the mortgage insurance industry consists of six private mortgage insurers.

In our 2017 Audit and Evaluation Plan, we identified the four areas that we believe pose the most significant risks to FHFA and the entities it supervises. One of those four areas is counterparty risk – the risk created by persons or entities that provide services to Fannie Mae or Freddie Mac. According to FHFA, mortgage insurers represent the largest counterparty exposure for the Enterprises. The Enterprises acknowledge that, although the financial condition of their mortgage insurer counterparties approved to write new business has improved in recent years, the risk remains that some of them may fail to fully meet their obligations. While recent financial and operational requirements may enhance the resiliency of mortgage insurers, other industry features and emerging trends point to continuing risk.

We undertook this white paper to understand and explain the current and emerging risks associated with private mortgage insurers that insure loan payments on single-family mortgages with LTVs greater than 80% purchased by the Enterprises. (2)

It is a truism that the next crisis won’t look like the last one. It is worth heeding the Inspector General’s warning about the

risks from private mortgage insurance as a credit enhancement, including increasing volume, high concentrations, an inability by the Enterprises to manage concentration risk, mortgage insurers with credit ratings below the Enterprises’ historic requirements and investment grade, the challenges inherent in a monoline business and the cyclic housing market, and remaining unpaid mortgage insurer deferred obligations. (13)

One could easily imagine a taxpayer bailout of Fannie and Freddie driven by the insolvency of the some or all of the six private mortgage insurers that do business with them. Let’s hope that the FHFA addresses that risk now, while the mortgage market is still healthy.

The Regulation of Residential Real Estate Finance Under Trump

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I published a short article in the American College of Real Estate Lawyers (ACREL)  (ACREL) News & Notes, The Regulation of Residential Real Estate Finance Under Trump. The abstract reads,

Reducing Regulation and Controlling Regulatory Costs was one of President Trump’s first Executive Orders. He signed it on January 30, 2017, just days after his inauguration. It states that it “is the policy of the executive branch to be prudent and financially responsible in the expenditure of funds, from both public and private sources. . . . [I]t is essential to manage the costs associated with the governmental imposition of private expenditures required to comply with Federal regulations.” The Reducing Regulation Executive Order outlined a broad deregulatory agenda, but was short on details other than the requirement that every new regulation be accompanied by the elimination of two existing ones.

A few days later, Trump issued another Executive Order that was focused on financial services regulation in particular, Core Principles for Regulating the United States Financial System. Pursuant to this second Executive Order, the Trump Administration’s first core principle for financial services regulation is to “empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth.” The Core Principles Executive Order was also short on details.

Since Trump signed these two broad Executive Orders, the Trump Administration has been issuing a series of reports that fill in many of the details for financial institutions. The Department of Treasury has issued three of four reports that are collectively titled A Financial System That Creates Economic Opportunities that are directly responsive to the Core Principles Executive Order. While these documents cover a broad of topics, they offer a glimpse into how the Administration intends to regulate or more properly, deregulate, residential real estate finance in particular.

This is a shorter version of The Trump Administration And Residential Real Estate Finance, published earlier this year in the Westlaw Journal: Derivatives.

Treasury’s Take on Housing Finance Reform

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Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.

Trump and the Regulation of Real Estate

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I have posted my article, The Trump Administration and Residential Real Estate Finance, which just came out in Westlaw Journal Derivatives to SSRN (and also to BePress). The abstract reads,

An executive order titled “Reducing Regulation and Controlling Regulatory Costs” was one of President Donald Trump’s first executive orders. He signed it Jan. 30, 2017, just days after his inauguration. It states: “It is the policy of the executive branch to be prudent and financially responsible in the expenditure of funds, from both public and private sources. … It is essential to manage the costs associated with the governmental imposition of private expenditures required to comply with federal regulations.” This executive order outlined a broad deregulatory agenda, but it was short on details other than setting a requirement that every new regulation be accompanied by the elimination of two existing ones. A few days later, Trump issued another executive order that was focused on financial services regulation in particular. That order is titled “Core Principles for Regulating the United States Financial System.” It says the Trump administration’s first core principle for financial services regulation is to “empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth.” However, it is also short on details.

Since Trump signed these two broad executive orders, his administration issued two sets of documents that fill in applicable details for financial institutions. The first is a slew of documents that were released as part of the Office of Information and Regulatory Affairs’ Current Regulatory Plan and the Unified Agenda of Regulatory and Deregulatory Actions. The second is a series of Treasury reports — titled “A Financial System That Creates Economic Opportunities” — that are directly responsive to the core principles executive order. While these documents cover a broad range of topics, they offer a glimpse into how this administration intends to regulate — or more properly, deregulate — residential real estate finance in particular. What is clear from these documents is that the Trump administration intends to roll back consumer protection regulation so that the mortgage market can operate with far less government oversight.

Are The Stars Aligning For Fannie And Freddie Reform?

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Law360 published my op ed, Are The Stars Aligning For Fannie And Freddie Reform? It reads,

There has been a lot of talk of the closed-door discussions in the Senate about a reform plan for Fannie Mae and Freddie Mac, the two mammoth housing finance government-sponsored enterprises. There has long been a bipartisan push to get the two entities out of their conservatorships with some kind of permanent reform plan in place, but the stars never aligned properly. There was resistance on the right because of a concern about the increasing nationalization of the mortgage market and there was resistance on the left because of a concern that housing affordability would be unsupported in a new system. It looks like the leader of that right wing, House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has indicated that he is willing to compromise in order to create a “sustainable housing finance system.” The question now is whether those on the left are also willing to compromise in order to put that system on a firm footing for the 21st century.

In a speech at the National Association of Realtors, Hensarling set forth a set of principles that he would be guided by:

  • Fannie Mae and Freddie Mac must be wound down and their charters repealed;
  • Securitizers need strong bank-like capital and community financial institutions must be able to compete on a level playing field;
  • Any new government affordable housing program needs to at least be on budget, be results-based and target actual homebuyers for the purpose of buying a home they can actually afford to keep;
  • The Federal Housing Administration must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.

I am not yet sure that all of the stars are now aligned for Congress to pass a GSE reform bill. But Hensarling’s change of heart is a welcome development for those of us who worry about some kind of slow-moving train wreck in our housing finance system. That system has been in limbo for nearly a decade since Fannie and Freddie were placed in conservatorship, with no end in sight for so long. Ten years is an awfully long time for employees, regulators and other stakeholders to play it by ear in a mortgage market measured in the trillions of dollars.

Even with a broad consensus on the need for (or even just the practical reality of) a federal role in housing finance, there are a lot of details that still need to be worked out. Should Fannie and Freddie be replaced with many mortgage-backed securities issuers whose securities are guaranteed by some arm of the federal government? Or should Fannie and Freddie become lender-owned mutual insurance entities with a government guarantee of the two companies? These are just two of the many options that have been proposed over the last 10 years.

Two housing finance reform leaders, Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., appear to favor some version of the former while Hensarling seems to favor the latter. And Hensarling stated his unequivocal opposition to some form of a “recap and release” plan, whereas Corker and Warner appear to be considering a plan that recapitalizes Fannie and Freddie and releases them back into private ownership, to the benefit of at least some of the companies’ shareholders. The bottom line is that there are still major differences among all of these important players, not to mention the competing concerns of Sen. Elizabeth Warren, D-Mass., and other progressives. Warren and her allies will seek to ensure that the federal housing system continues to support meaningful affordable housing initiatives for both homeowners and renters.

Hensarling made it clear that he does not favor a return to the status quo — he said that the hybrid GSE model “cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped.” But Hensarling also made it clear that he will negotiate and compromise. This represents a true opening for a bipartisan bill. For everyone on the left and the right who are hoping to create a sustainable housing finance system for the 21st century, let’s hope that his willingness to compromise is widely shared in 2018.

I am now cautiously optimistic that Congress can find some common ground. With Hensarling on board, there is now broad support for a government role in the housing sector. There is also broad support for a housing finance infrastructure that does not favor large financial institutions over small ones. Spreading the risk of default to private investors — as Fannie and Freddie have been doing for some time now under the direction of their regulator — is also a positive development, one with many supporters. Risk sharing reduces the likelihood of a taxpayer bailout in all but the most extreme scenarios.

There are still some big sticking points. What should happen with the private investors in Fannie and Freddie? Will they own part of the new housing finance infrastructure? While the investors have allies in Congress, there does not seem to be a groundswell of support for them on the right or the left.

How much of a commitment should there be to affordable housing? Hensarling acknowledges that the Federal Housing Administration should serve first-time homebuyers and low- and moderate-income individuals, but he is silent as to how big a commitment that should be. Democrats are invested in generating significant resources for affordable housing construction and preservation through the Affordable Housing Trust Fund. Hensarling appears to accept this in principle, while cautioning that any “new government affordable housing program needs to at least be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep.” Democrats can work with Hensarling’s principles, although the extent of the ultimate federal funding commitment will certainly be hotly contested between the parties.

My cautious optimism feels a whole lot better than the fatalism I have felt for many years about the fate of our housing finance system. Let’s hope that soon departing Congressman Hensarling and Sen. Corker can help focus their colleagues on creating a housing finance system for the 21st century, one with broad enough support to survive the political winds that are buffeting so many other important policy areas today.