The tremendous amount of uncertainty surrounding the finalization of Dodd-Frank is making financial institutions hesitant to inject capital into the jumbo mortgage lending space.
Of course, it doesn’t help the market shrunk from more than 50% of the market in 2006 to barely 5% this year. And worst of all there is no financing available, a factor likely to remain unchanged if the zero interest rate policy remains in force.
“There’s no financing,” Christopher Whalen, a senior managing director at Tangent Capital Partners, told Tom Keene on Bloomberg Television in early April. “In the New York area there is no financing available above $1 million dollars.”
“What that means is the private label jumbo market is gone and what’s on the books is running off and we are not replacing it,” he added. “As long as the Fed keeps rates at zero, there is not enough spread to bring investors back into the market.”
Whalen suggests that the jumbo market will not see any meaningful change until the Federal Reserve raises interest rates to 0.5%. The Fed, for its part, remains committed to leaving rates as is for the remaining year, maybe longer. One of the few companies attempting to restart the jumbo secondary market is Mill Valley, Calif.-based Redwood Trust, a real estate investment trust with its eyes set on loans primarily in California (geographic risk that could worry an investor). The firm is the only issuer of a private-label RMBS since the financial crisis struck in 2007. Since then, Fannie Mae, Freddie Mac and Ginnie Mae have funded more than 95% of the mortgage market.
Declining to comment on specific transactions, Michael McMahon, managing director of investor relations at Redwood, said the company “believes mortgage securitization will play a very significant role in picking up market share” as the U.S. reduces the role of government-supported bond guarantors Fannie Mae and Freddie Mac.
“We may be a bit early in rebuilding our conduit,” McMahon said. “But we have made significant progress in the number of clients we’re buying loans from, and we’re very happy with the results.”
In late March, Redwood sold its fifth privately funded RMBS to market tied to about $325 million of new home loans without government backing since the market froze in 2008. Redwood’s offerings since then have been backed by about $1.6 billion of loans. Nonagency MBS issuance peaked at $1.2 trillion in each of 2005 and 2006 before the market collapsed as foreclosures soared and home values plunged.
“They’re in the business of doing these sorts of deals, it’s in their interest to try to get the market going,” says Tom Millon, chief executive of Ponta Vedra Beach, Fla.-based Capital Markets Cooperative, a consortium of jumbo investors. “Buying and securitizing non-agency product is what they do. Without a functioning market there, they’re kind of hard pressed to execute on their business model.”
But the market can’t function as it waits for the finalization of the Dodd-Frank qualified mortgage proposal, which is expected to come by the end of June. At that point, lenders will know what to consider when determining a borrower’s “ability to repay.” For mortgages north of $800K, this is a major sticking point.
Furthermore, if home prices decline further this year, the deepening negative equity will amplify the rate of strategic default in those prime jumbo pools.
“It really is tied up with property values and, therefore, general economic conditions such as the strength of borrowers,” Millon says about the likelihood of Redwood’s actions occurring on a larger scale. “The general confidence in the entire market hinges on that, but I think it just becomes amplified in the world of jumbo loans because property values are so hard to ascertain.”
Once property values start rising investors will be interested and leverage will become available for REITs and similar entities to lever the return, Millon said.
So far, the only loans in the jumbo space being securitized are pristine. Only one borrower out of 1,800 newly originated prime loans the Redwood RMBS deals with is delinquent, according to Fitch Ratings.
“The good news is that these borrowers have been paying for the past five, six years. So they have shown a willingness and ability to pay. But how long with that willingness last? That is the big question,” says Moody Investors Service head of US RMBS Surveillance, Debash Chatterjee.
Actually, strategic defaults are generally contained and have been falling steadily since reaching a peak in early 2010, likely as a result of stabilizing home prices and a gradually improving economy, according to a recent Barclays Capital research report. “We foresee a continued drop in (strategic defaults) if home prices start to steadily appreciate, which we think will occur (in 2013).”
CONFORMING TO A LIMIT
In an effort to support the crippled mortgage finance, Congress in 2008 increased the conforming loan limit for Fannie Mae, Freddie Mac and Federal Housing Administration loans to a local cap of 125% of median home prices along with the overall ceiling of $729,000 in the most expensive neighborhoods.
Perhaps recognizing that its heavy subsidy of conforming loans wasn’t doing much to serve and reinvigorate the secondary mortgage-finance market, Congress lowered the cap to 115% of local medians on Oct. 1, 2011, despite major pushback from the housing industry and several lawmakers who were concerned that homeowners would not be eligible for government funding after the drop.
So far the change has had a minor effect on lending. Government-supported lending accounted for 88% of new mortgages and home-equity loans in 2011, with other debt of more than $417,000 representing 8.7% of the total, according to Inside Mortgage Finance. That jumbo share rose to 9.3% last quarter as Fannie Mae and Freddie Mac loan limits fell.
The National Association of Homebuilders was an ardent opponent of last fall’s drop in the conforming loan limit (which was subsequently raised for the FHA), claiming that more than 17 million homeowners would not be eligible for government funding if the conforming loan limit drops.
The association still holds this position.
“We’re not arguing that the limit should stay at the higher level for all time,” says David Ledford, NAHB senior vice president of regulatory affairs. “We were just saying that the change was made at a time when the market had not yet recovered and it still hasn’t and is very fragile. We’re arguing let’s let the market stabilize before we start making a lot of changes that make it more difficult for people to purchase.”
Henry Santos, senior executive at Accenture Credit Services, said he is not seeing any new market patterns as a result of the loan limit expiration.
“Step No. 1 was to lower the limit,” Santos says. “I think the market is still waiting to see if Step 2 is creating a different guarantee or some other option for jumbos. There’s a lot of dialogue that the Feds aren’t done with yet — maybe there’s going to be another solution. Operationally and working with our clients, I have not seen what I would call a trend at this juncture.”
JUMBO PAYOUTS TO INVESTORS
Major banks are struggling to gauge the amount of repurchase and warranty claims by private investors and government-sponsored enterprises.
The reckless lending resulting in the housing boom and a seismic wave of representation and warranty breaches by originators on loans pooled into nonagency MBS have been heavily reported, but very few rep and warranty-related payouts have been made to nonagency investors.
The only sizeable potential representation and warranty recovery so far is last year’s $8.5 billion settlement between Countrywide and Bank of New York Mellon which is, in itself, still preliminary and subject to judicial approval. Given the number of such lawsuits filed over the past year, analysts at Barclays believe that we are still in the early stages of these recoveries.
The investors in the lawsuit are appealing the settlement because they say it robs them of the opportunity to represent their own needs. But if the $8.5 billion settlement gives us a reasonable template of what other investors can hope to get paid on their claims, then potential rep and warranty-related payouts could reach $52 billion, Barclays calculates. That’s a gain of 3% to 6% of the current balance of the deals. And analysts at FBR Capital Markets project $64.18 billion in repurchase losses for nonagency MBS issued from 2005 through 2007 (2004 through 2008 for Bank of America).
Not surprisingly, the largest exposure to rep and warranty payouts lies with Bank of America. Barclay’s projected payout of $15.5 billion already consists of settlements that the bank has previously announced, including the $8.5 billion preliminary settlement on the vast majority of its Countrywide securitizations and the estimated $1.6 billion that it negotiated with Assured Guaranty last year.
“Removing these two amounts from the $15.5 billion suggests that Bank of America may incur future rep and warranty related liabilities to nonagency investors of $5 billion to $6 billion, primarily related to its Merrill Lynch sponsored deals,” says Jasraj Vaidya, residential credit strategist at Barclays.
JPMorgan, on the other hand, has not yet reached any major settlements with nonagency investors and continues to carry rep and warranty related exposure to its deals issued by itself or on its Bear Stearns, Long Beach and Washington Mutual exposure (some of which are already in legal battles).
As a result, nonagency investors in these deals could see settlement or court-adjudicated recoveries of $6 to $12 billion.
The remaining large financial institutions generally have significantly less exposure to rep and warranty related payouts because they either did not sponsor as many deals or were able to pass off the repurchase obligation to originators with whom they had purchased the loans.
“The settlements between the originators and the investor could lead to servicing transfers to less burdened servicers with incentives to provide modifications and short sales and other foreclosure alternatives,” Vaidya says. “These additional incentives offered to servicers to modify loans or conduct short-sales should also help borrowers to some extent.”
Those investors positioning for rep and warranty related payouts should focus on deals sponsored by the largest banks. And when searching for more jumbo securities, Chatterjee says investors should not just examine where the properties are located and the LTV ratios on the underlying loans, but also who the servicer is.
“This matters a lot because of loss mitigation,” says Chatterjee, whose firm analyzed the five largest mortgage servicers’ success rate in providing remedies for distressed jumbo loans.
Moody’s measured the percentage of first-lien loans that started a period more than 90 days past due or in foreclosure and a year later became current, paid off in full, were delinquent 60 days past due or less, or that the servicer modified.
In the fourth quarter of 2011, GMAC had the best jumbo loan rate cure rate at 32%, followed by Chase, Citi and then BofA. Wells Fargo fell from third to last, remedying only 19% of distressed jumbo loans.
Attending HousingWire’s REthink Symposium in March, Santos said he listened to a “great conversation” on stage about the idea of a public-private partnership where private capital is incentivized to return to the market and lend again at jumbo rates.
Private institutions would pay a guarantee fee to the Feds into a reinsurance program used as a first stop-loss position to help create security against the possibility of market pandemonium if unemployment returned to former heights.
“They’re going to have to decide if there’s a way for them to make money in that space or the banks are going to have to feel secure enough that they can offer that product to their constituents and manage the risk on their portfolio,” Santos says.
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