This is what justifies Texas economic pride

This is what justifies Texas economic pride

Happy Independence Day, Texas

Morgan Stanley expects mortgage bond lawsuit from New York AG

Subprime securitizations at the center of lawsuit

Things at Ocwen just went from bad to much, much worse

Embattled company hit with an avalanche of bad news


new REwired blog header
Opinion, commentary and analysis on everything that makes the U.S. housing economy tick -- not to mention the ghosts in the machine, too. Written by HW's team of editors and reporters each business day.

'Good politics' keep barriers to refinancing in place

December 2, 2010
Just before Thanksgiving Freddie Mac raised "postsettlement delivery fees" for certain mortgages with higher loan-to-value ratios. The move attracted little attention in the media, but sent the prepayment analysts scrambling to calculate the effect on outstanding mortgage-backed securities. Here's the thinking: Anything that raises the cost of borrowing also lowers the amount a borrower might save by refinancing into the same kind of loan with a lower rate (e.g. 30-year fixed rate to  30-year fixed rate). (There are other reasons to refinance — to tap equity, to shorten term to maturity, among others — but saving on the payment is the overwhelming inducement.) The lower the savings, the less incentive to enter the transaction. Likewise, anything that raises the cost of borrowing will, all else equal, lower affordability for borrowers. This in turn reduces demand, putting downward pressure on the sale prices of homes. Investor viewpoint Two natural audiences would be concerned about changes in home refinancing and purchase incentives: investors and law/policymakers. Let's approach it from the investors' point of view first. In simplest terms, MBS valued above par make higher returns and have less reinvestment risk the slower they prepay. Conversely, MBS held at a discount earn more the faster they prepay. The post-crash climate might be the most unfriendly to prepayments I've seen since I stumbled into mortgage research in the late 1980s: Housing has depreciated, leaving many would-be re-borrowers with no or negative equity. In addition, underwriting criteria have toughened, unemployment is high, many household incomes have been slashed and credit scores have suffered. Or, in other words — heaven for MBS investors holding coupons of 4% or higher. In this setting, Freddie's pricing adjustments are expected to have only a modest impact on prepayment rates. For example, analysts at RBS anticipate 1-2 constant prepayment rate might be shaved from speeds (the annualized rate, in percent, at which principal is prepaid). As another example, Credit Suisse projected 2008 vintage 5s could slow by 2-3 CPR. This isn't a lot. To put it in perspective, the universe of 30-year Freddies prepaid just inside 30 CPR in October 2010 according to, the universe of 5s at almost 34 CPR, the 2008 5s almost 46%. Widespread marginal impact A modest impact on prepayments does not mean few borrowers are affected. As a matter of fact, Credit Suisse prepayment scientists estimate that the percentage of borrowers affected in recently issued (2008 and later) MBS ranges from 50% to 60% in 30-year Freddie 4s and 4.5s, to 69% to 75% of 5s, 70% of 5.5s, 66% of 6s and 60% of 6.5s. Affected borrowers fall into two groups. The first are borrowing more than 70% of the appraised value (75% for credit scores 740 or more) without secondary financing. They face a new 25 basis-point delivery fee on loans sold to Freddie; another 25 basis points are added for borrowers with credit scores below 740 borrowers and more than 80% of the appraised value. Borrowers who qualify for the Housing Affordable Refinancing Program, or HARP, (labeled Relief Refinance mortgages by Freddie Mac) face the same fee increases, but there is a 200 basis-point cap on total fees which insulates borrowers with credit scores below 680. The second group is borrowers with secondary financing. The increases range from 25 to 75 basis points, with the steepest fee increases levied on those borrowing 75% to 80% in the first, Freddie loan and using a second mortgage to get to a combined loan to value of 76% to 90%. Hefty prices Bear in mind that these are increases on top of delivery fees of 25 basis points or more depending on credit score, LTV/CLTV, loan purpose, occupancy and other factors. I wrote about these affordability-reducers in the September 2010 HousingWire magazine "Housing finance reform? Start with mortgage pricing!" I'll just quote myself: "They easily add up to a pretty hefty surcharge" on the headline mortgage rate given to the cleanest prime loans. In that article, I gave an example for a 30-year fixed rate purchase money mortgage, credit score 670, 80% LTV, 95% CLTV, using Fannie's fee matrix (dubbed Loan Level Pricing Adjustments or LLPA), which I can update from Freddie's new fee structure: All loans                   =        25 basis points Credit Score/LTV            =       275 Secondary Financing       =       100 basis points Total                        =      400 basis points These fees are charged as points, like origination and discount points, but they are normally covered by an adjustment to the loan rate. The higher rate generates additional premium over par when the loan is sold. One point converts into 25 basis points of running interest rate. In this example, the borrower would pay a rate 1% higher than on the cleanest Freddie loan, with credit scores 700 or better and 60% or less LTV. In the September article, using Fannie pricing for the same risk characteristics, the rate was about 93 basis points higher than the best rate. Note that Fannie hasn't yet given any sign it will follow Freddie's lead here. If it doesn't tweak its LLPAs, Credit Suisse predicts Fannie will expand its market share, as roughly 40% of new loans sold to Freddie would be affected by the changes. The CS analysts also point out that only Relief Refinancing borrowers are affected by the changes since they can't jump to a Fannie lender for a HARP loan. I'm not so sure it alters market dynamics. Another 25 basis points of delivery fee or about 6 bp of additional loan interest translates to less than $5 additional monthly payment on a 5% loan. And, as Freddie points out in Bulletin 2010-30, the lender controls how the increase in fees would be factored into mortgage pricing. Freddie's motive Freddie is protecting its book of business. Here's what they said: "These delivery fee changes address the current increased risk and costs associated with certain higher loan-to-value mortgages. The changes help to ensure that we are adequately compensated for the continued provision of essential liquidity to the mortgage market, and are able to continue our support for affordable lending while being diligent stewards of taxpayer funding." As a taxpayer, this argument appeals to me. But this explanation only implies one aspect of Freddie's compensation — fees covering risk of losses. What goes unsaid is that these fees also protect Freddie from prepayments on performing loans (just as LLPAs protect Fannie). The two government-sponsored enterprises, which together hold in portfolio $1.5 trillion of loans and mortgage securities, are essentially looking for the same advantage that banks, mutual funds and other institutional investors want from "credit impaired" loans: an extension on the stream of premium (above current market rates) interest on loans that are more difficult to refinance. The overwhelmingly common credit impairment is loss of equity as home prices continue to sink, but household incomes and credit histories are also vulnerable in this economy. Delivery fees and LLPAs not only add another impediment to refinancing and retardant to home sales, protecting current investment income. They also retard prepayment of securitized loans on which the GSEs are collecting guarantee fees — on the order of 15 basis points of interest stripped from each loan. Is this a policy issue? Obstacles to refinancing don't appear to have much traction in Washington, except perhaps as a political football. For example, last summer, David Greenlaw, an economist at Morgan Stanley, ignited a firestorm by proposing the government streamline the refinancing process for borrowers with high LTV mortgages backed behind Fannie, Freddie and Ginnie MBS. His proposal called for refinancing without a credit evaluation. After all, the government has the credit exposure no matter what it does. By Greenlaw's calculation, the result would be to give homeowners almost $50 billion a year in fresh spending money. The concept was even offered up to a Senate Budget Committee hearing Aug. 3. The firestorm began when bloggers redistributed the suggestion as a fully formed "back-door stimulus" plot by the Obama Administration aimed at public opinion going into the election. The administration, of course, had no such plans. Or such options, given the charters Congress gave the GSEs. It had already done what it intended to do to simplify refinancings of GSE mortgages into new GSE mortgages up to 125% LTV with HARP, and FHA loans already had pretty frictionless streamline refinancing procedures. Investors, however, went into a tizzy fearing some kind of force majeur refinancing festival. Market prices of premium MBS were crushed. According the CS analysts, as late as Sept. 21, prices of Fannie 6s implied 100% probability that an "auto-refi event starting in 12 months" would cause prepayments to peak at 50 CPR, 90% probability of peaking at 70 CPR and 59% of peaking at 85 CPR. (85 CPR sustained for a year means 85% of the principal outstanding prepays. Whoosh. Must be reinvested at lower rates. Much anticipated income gone.) Those fears have finally relaxed. Pricing as of Nov. 17 implies zero probability that prepayments will shoot up from the current pace. Anyway, the delivery charges and LLPAs are not the biggest obstacle to refinancing, they are what JP Morgan analysts have call "another friction in the process." The real obstacles are inadequate or negative equity and the widespread use of secondary financing, either in the form of piggy-back loans or home equity lines of credit, often handed out to borrowers, along with complementary credit cards, at closing of the primary mortgage. Second mortgages These are the problems that bedevil modification efforts as well. Don't listen to me. Here's Laurie Goodman, senior managing director at Amherst Securities, on the subject in an Oct. 1 report on the housing crisis, ".... a disproportionate amount of borrowers with negative equity have seconds. The largest banks, who are also the largest second-lien holders, have (very successfully) defended the second liens." A borrower seeking to refinance a primary loan where a second mortgage also exists is in a tight spot. When the first lien is paid off, the second lien jumps to first position. The second mortgage holder has to agree to re-subordinate. Pause for a moment and consider what hoops you'd have to jump through to work through the faceless minions at a bank to secure that agreement. There is rich, loan-level data available from FirstAmerican CoreLogic's LoanPerformance databases on the extent of secondary financing in loans backing PLS. According to analysis done by Amherst Securities, more than 50% of first liens in PLS have a second or more subordinate lien behind them. The extent to which GSE borrowers have second liens is not readily ascertained. Freddie has discloses CLTV at origination along with other pool data, if the secondary financing was disclosed at the loan closing (the information goes back to December 2005). But Fannie, the larger of the two, and the de facto generic, does not. Certainly the GSE percentage would be less than 50%, but how much less we can only guess (or pray). We do know that private mortgage insurers, once the principal source of credit support for GSE loans, covered a 15.7% share of total mortgage originations in 2000, but that steadily shrank as the financing/housing bubble grew, to lows of 8.5% in 2005, 8.9% in 2006. My friends at kindly did a quick summary of Freddie's pool level disclosures for me. The results don't answer the question, how many GSE borrowers are encumbered with second mortgages, but they do suggest the problem peaked in 2007, as PLS markets — and private lending for securitization — shut down and the GSEs stepped in to provide ongoing liquidity to housing. Compare the LTV to the CLTV, starting in 2006, the first full year of CLTV reporting: LTV            CLTV            Dif 2006            74.7            76.8            2.1 2007            76.9            79.6            2.7 2008            74.8            76.4            1.6 2009            68.8            70.9            2.1 The effect of much tougher underwriting, reinforced by the risk-based delivery fees,  has been to push LTV/CLTVs sharply down, despite the erosion of home market values. Paying lip service I've found no evidence policy/law makers are distressed by the delivery-fee/LLPA surcharges. And they don't seem to get beyond paying lip service to the problem of second liens. The Dodd-Frank Act does not address this issue, either as a present obstacle to refinancings and modifications, or as a serious consideration for regulators writing rules to define the "qualified mortgages" that will be exempt from risk-retention requirements on private securitizations. The administration finally got its second mortgage modification program off the floor in March, but it's voluntary. And as Laurie Goodman points out, it requires the second lien to be treated essential pari passu. That is, to the degree the first reduces interest, the second reduces interest. Ditto with forebearance and foregiveness of principal. This is illogical — if the property were liquidated, the second mortgage is likely to receive nothing after servicers advances and expenses of foreclosure and liquidation are repaid and first lien holder claims are satisfied. Bank-government collusion There's a very good reason why the government has been so gentle with second liens. The largest servicers are the largest second-lien holders. Analysis by Amherst Securities in March 2009 showed that the top four servicers, Bank of America, Wells Fargo, Chase and CitiGroup, with a 55% share of the servicing market, owned 52% of residential revolving lines of credit held by all FDIC insured institutions, and another $93.6 billion of closed-end 2nds. Altogether, as of the end of 2008, they had $441 billion of second lien loans. My conclusion: The delivery fees are a necessary evil. The GSEs charge for the risk the taxpayers are on the hook for. No matter that the taxpayers might see the light at the end of the tunnel sooner if they — and the economy — had more discretionary funds and more reason to hang in, though they are up to their necks in mortgage debt. The right-leaning furor over the imagined force majeure, no credit/no appraisal refi plan last summer suggests there is no political risk in keeping them in place. On the other hand, banks seem to think that two loans are more profitable than one. And campaign cash from the financial industry played a huge role in the last election. I don't see any solution to the second mortgage problem coming up when the 112th Congress convenes.
Comments powered by Disqus