It is true. Owning a home has never been more affordable for those with the credit history to qualify for a mortgage.
Thanks to the Federal Open Market Committee, interest rates will remain at or near historic lows into 2014 and maybe even beyond with the latest round of the seemingly unending bond-buying program known as QE3.
But even as one arm of the government attempts to keep the costs of owning a home down, another will soon raise them.
On Aug. 31, the Federal Housing Finance Agency, steward of the largest mortgage financiers in the U.S., Fannie Mae and Freddie Mac, said it would raise the guarantee fees each entity charges lenders by 10 basis points to securitize loans and insure the timely interest and principal payments for investors. The plan to do so was announced earlier in the year in order to encourage private capital back into the market.
For loans sold to the government-sponsored enterprises for cash, the higher fees go into effect Nov. 1. For others exchanged for mortgage bonds, the effective date is Dec. 1.
Lenders paid an average 28 basis points in 2011 for Fannie and Freddie to guarantee their loans in the bonds issued to investors, up from 26 bps the year before, according to a report released by the FHFA when it raised them.
But it said the new raises will narrow the gap between what Fannie and Freddie charge lenders who deliver large volumes of loans with those who originate fewer.
The GSEs will also increase fees on mortgages with maturities longer than 15 years higher than those home loans with shorter terms. This, the FHFA said, will reduce cross-subsidies between higher-risk and lower-risk mortgages.
“These changes will move Fannie Mae and Freddie Mac pricing closer to the level one might expect to see if mortgage credit risk was borne solely by private capital,” said FHFA Acting Director Edward DeMarco.
HIGHER FEES FOR SOME STATES
But just as importantly in its announcement, the FHFA said it may have additional raises to come. Not just nationally. But in specific states where the agency aims to offset high costs for carrying a loan all the way through a backlogged and lengthy foreclosure process. The irony is that servicing shops at the GSE’s largest lending banks had a hand in doing the lengthening. The robo-signing scandal that struck in 2011 brought the foreclosure system to an absolute standstill and spurred advocate lawmakers around the country to build in costly and elongated protections such as the end of dual-tracking and the creation of single point of contacts for distressed borrowers.
State-by-state, the foreclosure laws are an entangled puzzle of judicial and nonjudicial requirements, and may contain elements of both like in California, a state that recently passed a homeowner bill of rights.
The GSE system for determining how to price its fees is equally convoluted, more art than science. This from a study released in August is a taste of the complexity:
“Fannie Mae and Freddie Mac consider many factors in determining the guarantee fees they charge, including the estimated cost of guaranteeing specific mortgages derived from their costing models, competitive conditions in the market for bearing mortgage credit risk, the relative pricing of each enterprise’s MBS, the enterprises’ public mission, and return-on-capital targets.”
But here’s the kicker:
“No set formula exists for weighing those factors. Instead, each enterprise weighs them differently and works toward its view of a balanced outcome in line with market conditions and company goals.”
So, at first glance, it would seem new homeowners, the very people the housing market is depending on to heal a broken system, will shoulder the burden of these new rules in five key states: New York, Florida, New Jersey, Connecticut and Illinois. According to the FHFA, this isn’t so. At least, not yet. That cost may come later.
“The approach set forth in this notice is based on enterprise experience and does not include the forward-looking impact of recently enacted state and local laws that may increase the enterprises’ costs. FHFA intends to periodically reassess state-level pricing based on updated enterprise data,” the FHFA said in its notice of proposed rulemaking for raising the g-fees in five particular states. “The agency may include the impact of newly enacted laws if they clearly affect foreclosure timelines or costs, where such costs may be reasonably estimated based on relevant experience.”
THE FIVE STATES
G-fees are expected to climb so high in New York, at least one analyst recommended bond investors buy securities concentrated there because the prepayment risk would drop.
The latest proposal from the FHFA could raise g-fees by an additional 30 basis points in New York, followed by a 20 bps increase in Florida, New Jersey, Connecticut, and finally an extra 15 bps raise in Illinois beginning in 2013.
“FHFA recognizes that the data the enterprises have used to calculate state-level cost differences in this proposal are based on a combination of enterprise experience and estimation,” the agency explained. “Actual costs incurred by the enterprises in the future may vary over time and among individual defaults within a state. Because of this variability, FHFA’s planned approach focuses on five states that are clear outliers among states in terms of their default-related costs.”
Sarah Hu with the Royal Bank of Scotland said the increase could keep some borrowers in the state from refinancing. Upfront fees would not be worth the lower mortgage rate, which would end up being higher compared to other areas.
“Given that New York prepayment levels are already lower than many other states (due to its higher mortgage taxes), an additional 30 bps g-fee hike will further slow refinancing activity in the state,” Hu said. “We believe that pools with high New York geographic concentrations should provide good prepayment protection.”
The agency provides an example, which sounds less expensive than it actually is. Under the planned approach, a homeowner could pay up to $7 more per month for a $200,000 mortgage set at a 30-year fixed rate. That equals out to roughly $84 per year, but over the life of a loan, a borrower could end up paying $2,500 more for their mortgage with the g-fee increase.
How the FHFA came to these raises comes in three parts.
Agency analysts looked first at the expected number of days it takes a servicer to foreclose and obtain marketable title on a GSE loan in a particular state.
In New York, this takes — on average — a remarkable 820 days. That’s more than two years. Two years prior, the nation was voting in a swarm of new Tea Party Republicans, whose majority eventually allowed the GOP to take over the House in 2010.
In New Jersey, it takes on average 750 days to foreclose and take a marketable title, followed by 690 days in Connecticut, 660 days in Florida and 540 days in Illinois.
The national average, according to the FHFA, is 413.
The second part of the equation is the average per-day carrying cost in a particular state. In Illinois, this price is 18% higher than the national average followed by a 13% premium in New Jersey, 12% higher in New York, 11% more in Florida and a 9% increased cost in Connecticut.
Outside of Puerto Rico, Texas enjoys the largest discount, compared to the national average. There, the GSEs pay 18% less to carry a loan through foreclosure.
Finally, the FHFA considered the expected national default rate before it determined its g-fee pricing.
“To estimate the magnitude of the state-level differences in average total carrying cost, the estimation assumes that loans originated in each state will default at the national average default rate,” the FHFA said.
Factor each of these three components, and the five lowest ranked states get the higher g-fees. Interestingly, the top-ranked state (meaning, the place where it cost the GSEs the less to foreclose, based on this formula) was Virginia.
PRIVATE MARKET IMPLICATIONS
Will this get the private mortgage market to return?
It depends who you ask.
The analysts at FBR Capital Markets correctly said for months that the FHFA would pass on the Treasury Department’s higher offer on principal reduction reimbursements. In July, FHFA Acting Director Edward DeMarco did that very thing. It was unpopular, but to him, it protected taxpayers from unnecessary risks to the GSEs.
With the g-fee raises, here we are again. But this time, FBR analysts were split, depending, again, on who they asked.
They mostly aligned themselves with Wells Fargo executives on the question. Probably because the San Francisco bank is the largest mortgage lender in the U.S. By a lot. Wells originated more mortgages in the second quarter than what each of the other top four banks wrote combined.
Wells Fargo said it would take a lot more than a g-fee of even 50 bps (again, last year lenders paid between 26 bps and 28 bps) to bring the private-label market back. A slew of still pending Dodd-Frank rules remain as a hurdle, included the qualified mortgage standards, proposed capital regulations, and a fundamental distrust of the ratings agencies.
Said one residential mortgage-backed securities issuer, who asked to remain nameless, about the credit ratings agencies: “Everybody on the buyside does their own homework now.”
But JPMorgan Chase executives told FBR a different story. And it also may hint at what the bank — the largest in the U.S. by assets — has planned. Chase said increasing the g-fee to 50 bps would actually reboot the private-label RMBS market again.
The economics of holding these loans on their balance sheet and securitizing them will become more attractive, Chase executives said. At a 50 bps level, the GSEs would be pricing risk four to five times higher than expected losses.
“Should this occur, (Chase) stated that it would like to re-enter the market in a meaningful way, taking market share away from the GSEs,” FBR said. “We note that before any of this could take place, we would need the final rules on QM, QRM, and capital standards.”
So in a way, maybe it took the foreclosure process to be broken in order to get the private-label securitization market back up and running a little faster. It just takes higher g-fees — and new homeowners — to pay for it.