Tag Archives: Standard & Poor’s

Mortgage Servicing Since The Financial Crisis

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photo by Dan Brown

Standard & Poors issued a report, A Decade After The Financial Crisis, What’s The New Normal For Residential Mortgage Servicing? It provides a good overview of how this hidden infrastructure of the mortgage market is functioning after it emerged from the crucible of the subprime and foreclosure crises. It reads, in part,

Ten years after the start of the financial crisis, residential mortgage servicing is finally settling into a new sense of normal. Before the crisis, mortgage servicing was a fairly static business. Traditional prime servicers had low delinquency rates, regulatory requirements rarely changed, and servicing systems were focused on core functions such as payment processing, investor accounting, escrow management, and customer service. Subprime was a specific market with specialty servicers, which used high-touch collection practices rather than the low-touch model prime servicers used. Workout options for delinquent borrowers mainly included repayment plans or extensions. And though servicers completed some modifications, short sales, and deeds in lieu of foreclosure, these were exceptions to the normal course of business.

Today, residential mortgage servicing involves complex regulation, increased mandatory workout options, and multiple layers of internal control functions. Over the past 10 years servicers have had to not only modify their processes, but also hire more employees and enhance their technology infrastructure and internal controls to support those new processes. As a result, servicing mortgage loans has become less profitable, which has caused loan servicers to consolidate and has created a barrier to entry for new servicers. While the industry expects reduced regulatory requirements under the Trump administration and delinquency rates to continue to fall, we do not foresee servicers reverting to pre-crisis operational processes. Instead, we expect states to maintain, and in some cases enhance, their regulatory requirements to fill the gap for any lifted or reduced at the federal level. Additionally, most mortgage loan servicers have already invested in new processes and technology, and despite the cost to support these and adapt to any additional requirements, we do not expect them to strip back the controls that have become their new normal. (2/10, citation omitted)

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As The Economy Improves, Delinquency Rates Have Become More Stable

Total delinquency rates have only just begun returning to around pre-crisis levels as the economy–and borrowers’ abilities to make their mortgage payments–has improved (see charts 1 and 2). Lower delinquency rates can also be attributed to delinquent accounts moving through the default management process, either becoming reperforming loans after modifications or through liquidation. New regulatory requirements have also extended workout timelines for delinquent accounts. In 2010, one year after 90-plus delinquency rates hit a high point, the percentage of prime and subprime loans in foreclosure actually surpassed the percentage that were more than 90 days delinquent–a trend that continued until 2013 for prime loans and 2014 for subprime loans. But since the end of 2014, all delinquency buckets have remained fairly stable, with overall delinquency rates for prime loans down to slightly over 4% for 2016 from a peak of just over 8% in 2009. Overall delinquency rates for subprime loans have fluctuated more since the peak at 29% in 2009. (2/10)

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Modifications Now Make Up About Half Of Loan Workout Strategies

Government agencies and government-sponsored enterprises (Fannie Mae and Freddie Mac) developed new formal modification programs beginning in 2008 to address the rising delinquency and foreclosure rates. The largest of these programs was HAMP, launched in March 2009. While HAMP was required for banks accepting funds from the Troubled Asset Relief Program (TARP), all servicers were allowed to participate. These programs required that servicers exhaust all loss mitigation options before completing foreclosure. This requirement, and the fact that servicers started receiving incentives to complete modifications, spurred the increase in modifications. (4/10)

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Foreclosure Timelines Have Become Longer

As the number of loans in foreclosure rose during the financial crisis, the requirements associated with the foreclosure process grew. As a result, the time it took to complete the foreclosure process increased to almost 475 days in 2016 from more than 160 days in 2007–an increase of almost 200%. While this is not a weighted average and therefore not adjusted for states with smaller or larger foreclosure portfolios, which could skew the average, the data show longer timelines across all states. And even though the percentage of loans in foreclosure has decreased in recent years (to 1% and 9% by the end of 2016 for prime and subprime, respectively, from peaks of 3% in 2010 and 13% in 2011) the time it takes to complete a foreclosure has still not lessened (6/10)

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.

Divvying up The Mortgage Market

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photo by Evan-Amos

S&P Capital IQ has posted some Structured Finance Research: The Conforming Loan Limit And Its Effect On The U.S. Private­-Label Mortgage Market. It contains interesting thoughts on how a stabilized secondary mortgage market should be split between government-backed and private-label securitizations. More particularly, it finds that

  • The U.S. private­-label mortgage market has failed to recapture the market share that it ceded to the agency [Fannie & Freddie] market after the financial crisis of 2007–2009.
  • Partly because of changes in underwriting requirements, the private­-label market is synonymous with jumbo collateral: loans that exceed the conforming loan limit set by the Federal Housing Finance Agency (FHFA).
  • As a result, the conforming limit now acts as a gateway, controlling how much financing and securitization volume is accommodated by the agency channel relative to that of the private­-label market. (1)

It notes, “As rising home prices restore the historical relationship between the conforming limit and median home price, it will be interesting to see if there is a corresponding return to the pre­-2003 market share split between agency and private­-label securitization.” (Id.)

S&P further explains that

For the last 10 years, the conforming limit (which herein excludes dwellings with more than one unit) has remained at $417,000. Historically, the ratio of the median new home sale price to the conforming loan limit has been near 50%. When the housing market crashed, the ratio dropped to near 40%. However, the recovering housing market is restoring the historical relationship. Because the conforming loan limit acts as mechanism to regulate the market share breakdown between the private­-label and agency markets, it is likely to be a determinant in the future growth of the struggling private­-label sector.

Private-Label/Agency Market Share

Prior to 2003, the market share of the agency sector was a bit greater than 80%, with the remainder being private­-label issuance. After 2008, however, the agency share rose to over 95%. So while a new equilibrium appears to have been achieved, it is one in which a good deal of market share has been shifted away from the private-­label market and absorbed by the agencies. While the general market consensus seems to be that the private­-label share might not reach 2005–2007 levels again, the question remains as to when (if at all) the private­-label mortgage market will recover to the levels of issuance prior to 2003.” (1-2, chart omitted)

Implicit in all of this is that the pre-2003 state of affairs reflects some kind of natural state of equilibrium. This ignores the fact the national mortgage market has always been one that the government has shaped. While it is worth considering what balance between government and private-label securitization is best, historical precedent in itself is an insufficient guide.

I would rather focus on fundamentals. Should the government subsidize residential mortgages? How much exposure should the government have to credit risk? How much credit risk can the private sector handle? Should the government incentivize the origination of mortgage products (like the 30 year FRM) that private-label investors might not find so attractive? I care about the answers to these questions a whole lot more than I care about how the secondary mortgage market was divvied up one or two decades ago.

Economic Factors That Affect Housing Prices

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photo by TaxRebate.org.uk

S&P has posted a paper on Economic Factors That Affect Housing Prices. This is, of course, an important topic, albeit one that is an art as well as a science. While S&P undertook this analysis more for mortgage-backed securities investors than for anyone else, it certainly is of use to the rest of us. The paper opens,

The U.S. domestic housing market has experienced a 23% price increase since the beginning of the housing recovery in 2011. Many local housing markets are now close to or above their peak levels of 2006, which leads us to investigate whether the pace of home price appreciation (HPA) can continue at its current pace. In this paper, we (1) examine the economic factors that influence HPA and (2) forecast HPA for numerous geographic regions assuming various economic conditions over the next five years. While the aggregate national pattern in housing prices is an important reference, we need to examine housing prices at a more granular geographic level in order to understand regional housing market dynamics and learn how these are affected by local macroeconomic factors. This paper demonstrates that several economic variables are needed to predict average home price movements for each of 48 different U.S. metropolitan statistical areas (MSAs).

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Factors that influence HPA can be difficult to predict. Therefore, residential mortgage backed securities (RMBS) investors frequently use a range of HPA projections to estimate their potential bond returns. With that in mind, for each MSA, we considered five separate hypothetical economic scenarios, ranging from an “Upside” forecast to an extreme “Stress 3” case. Interestingly, our Stress 3 case forecasts a 28% decline in HPI at the national level over the next five years, which corresponds roughly to the decline experienced in the last recession. Our “base case” scenario leads to forecasts at the national level of a 26% increase in HPI over five years. This represents what we believe to be the most likely economic forecast. (1-2)

S&P’s key findings include:

  • Movement in HPA is primarily influenced by up to five variables, depending on the MSA: housing affordability, changes in shadow inventory, the unemployment rate, the TED spread [a measure of distress in the credit markets], and population growth.
  • HPA in many MSAs has momentum, meaning that it depends on its level in the previous quarter of observation.
  • The mortgage rate generally appears to have little predictive power in connection with home prices.
  • Chicago, Houston, Boston, and San Francisco are projected to appreciate at a greater pace (45%, 40%, 27%, and 36%, respectively) than the 26% forecast for the nation as a whole over the next five years, and New York at a slower pace (21%). Columbus led all MSAs with a projected five-year HPA of 50%.
  • Under our most pessimistic (Stress 3) scenario, Chicago is forecast to experience a greater decline in HPI (34%) over the next five years than the nation as a whole (29%), while New York, Boston, Houston, and San Francisco are projected to experience declines that are less severe than that of the nation (19%, 3%, 17%, and 16%, respectively). Markets that have been vulnerable in the past (Las Vegas, Phoenix, and Riverside) are projected to experience the greatest five-year declines under our Stress 3 scenario (66%, 68%, and 68%). The markets that show the greatest movements are the most sensitive to the five factors and frequently show the greatest upside and downside. (2-3, emphasis in the original)

I found the first and third bullet points to be the most interesting, as many pundits weigh in on the factors that affect housing prices. It will be interesting to see if further research confirms S&P’s findings.

Monday’s Adjudication Roundup

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Hypothetically Reforming Fannie and Freddie

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Ben Turner

S&P issued a report, Fannie, Freddie, and the FHLB System: Plus Ca Change . . . The report opens, “Despite reform talk in the years since the U.S. housing crisis, Standard & Poor’s Ratings Services believes the likelihood of extraordinary government support for key U.S. housing government­-related entities (GREs) Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB) system remains “almost certain” in case of need.” (1) Notwithstanding the fact that S&P expects that this extraordinary support will last well into the next presidential administration, S&P “can envisage three “tail risk” scenarios in which such support could become less likely under certain conditions, but view each of these scenarios as improbable.” (1) The three scenarios, which S&P characterizes as plausible, albeit improbable, are

  • An electoral sweep, with favorable macroeconomic conditions and few competing legislative priorities;
  • Court judgments, pursuant to shareholder lawsuits, forcing the legislators’ hand; or
  • A renewed housing market crisis, with one or more of these GREs viewed as more cause than cure. (4)

In the first scenario, “an election gives one party control of all three legislative actors (the president, House of Representatives, and Senate), precluding the need for bipartisan compromise to enact major reforms to Fannie and Freddie via legislation.” (4)

In the second, Fannie and Freddie shareholders win lawsuits that stem from the “U.S. Treasury’s decision to modify, in 2012, the Preferred Stock Purchase Agreements (PSPAs) governing the terms of its financial support to Fannie and Freddie . . ..” (4)

The final scenario,

is a renewed housing market crisis, on a scale at least similar to that of 2008. Like the other two scenarios, we don’t view this as likely, at least in the coming few years . . . perhaps as a result of the unfortunate confluence of several negative surprises- ­­including, for example, overreaction to Federal Reserve monetary policy normalization, terms­-of­-trade shocks (geopolitical conflicts that cause a rapid and dramatic spike in energy costs, perhaps), fresh financial sector  problems that suddenly tighten the sector’s funding costs, and an abnormally long spell of bad weather. (5)

This seems like a pretty reasonable analysis of the likelihood of reform for Fannie and Freddie. But that should not stop us from bemoaning Congressional inaction on this topic. Obviously, Congress is too ideologically driven to bridge the gap between the left and right, but the likelihood that we are building toward some new kind of crisis increases with time. I can’t improve on S&P’s analysis in this report, but I’m sure unhappy about what it means for the long-term health of our housing finance system.

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Reiss on $1.5B S&P Settlement

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Westlaw Journal Derivatives quoted me in S&P Settles Fraud Suits for $1.5 Billion. The story reads in part,

Standard & Poor’s has agreed to pay $1.5 billion to settle lawsuits filed by the U.S. Department of Justice, 19 states and a pension fund that accused the ratings agency of damaging the economy by inflating credit ratings in the years leading up to the 2008 financial crisis.

According to a statement issued Feb. 3 by S&P, a subsidiary of McGraw-Hill Cos, the ratings agency will pay $687.5 million each to the DOJ and the states. It also will pay $125 million to settle a lawsuit filed by California Public Employees’ Retirement System. Cal. Pub. Employees’ Ret. Sys. Moody’s Corp. et al., No. CGC-09-490241, complaint filed (Cal. Super. Ct., S.F. County July 9, 2009).

The parties filed a joint stipulation of dismissal with the U.S. District Court for the Central District of California on Feb. 4.

“After careful consideration, the company determined that entering into the settlement agreement is in the best interests of the company and its shareholders and is pleased to resolve these matters,” McGraw-Hill said in the statement.

S&P did not admit to any wrongdoing in agreeing to settle.

U.S. Attorney General Eric Holder announced the settlement for the Justice Department and states.

“On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” he said in a statement.

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David Reiss, a professor at Brooklyn Law School, also said the settlement closes an important chapter of the crisis.

“S&P would have faced a lot of unquantifiable risk if it had to admit wrongdoing in the settlement,” he said. “It is unclear that the Justice Department would have wanted to expose one of the three major rating agencies to such a risk because it could have destabilized the rating agency industry.”

Reiss added that the $1.5 billion settlement should have a deterrent effect.

”[It] likely gives ratings analysts some firm ground to stand on if they are pressured to lower their standards by others in their organizations,” he said. (1, 18-19)

The article also has a sidebar that reads,

Ratings agencies had avoided liability for their actions for quite some time based on the theory that they were First Amendment actors who dealt in opinions.

Recent cases have held that the rating agencies can be held liable for some of their ratings notwithstanding the First Amendment. United States v. McGraw-Hill Cos. et al., No. 13-CV-0779, 2013 WL 3762259 (C.D. Cal. July 16, 2013) and Federal Home Loan Bank of Boston v. Ally Financial Inc. et al., No. 11-10952, 2013 WL 5466631 (D. Mass. Sept. 30, 2013).

For instance, if the rating agency did not follow its own rating procedures, it could be held liable for fraud.

—David Reiss, Brooklyn Law School (18)