Nov. 15: Letters on Basel III, LTV’s impact on credit, and lenders marketing to CPAs instead of Realtors

Rob Chrisman

Rob Chrisman began his career in mortgage banking – primarily capital markets – 31 years ago in 1985 with First California Mortgage, assisting in Secondary Marketing until 1988, when he joined Tuttle & Co., a leading mortgage pipeline risk management firm. He was an account manager and partner at Tuttle & Co. until 1996, when he moved to Scotland with his family for 9 months. Read more...

The recent elections prompted Hal M. to write and remind me of “crab mentality”. “’Crab mentality’ sometimes referred to as crabs in the bucket, is a phrase that describes a way of thinking best described by the phrase, ‘If I can’t have it, neither can you.’ The metaphor refers to a pot of crabs. Individually, the crabs could easily escape from the pot, but instead, they grab at each other in a useless ‘king of the hill’ competition which prevents any from escaping and ensures their collective demise. The analogy in human behavior is that members of a group will attempt to ‘pull down’ (negate or diminish the importance of) any member who achieves success beyond the others, out of envy, conspiracy or competitive feelings.’ Sadly, my experience is that crabs are more often the rule than the exception.”

 

Lots of folks in real estate and lending want one of those jobs where people ask, “Do you mean you actually get paid for doing this?” Instead we find ourselves, including me of course, debating things like the merits of 97% LTV loans. Reagan Walters, a Compliance Officer with Patriot Bank Mortgage, writes, “Here are my 2 cents on raising LTVs. I just can’t stand the fact that we are even debating this idea. On a 95% loan Fannie will allow 3% of the down payment to be a gift. Freddie will allow a non-occupying co-borrower as long as the occupying borrower makes $1 in income. Both of these scenarios show that the borrower possibly has access to funds should an emergency arise – since they couldn’t save for their own down payment. My issue is that if you lower the required down payment, you will have more potential homeowners, thus spurring on economic growth, yadda, yadda, yadda. These buyers couldn’t even save 5% for a down payment. What are they going to do about the increased costs of home ownership versus renting? Home maintenance, yard, increased energy bills, etc. What will happen when the heater completely dies? Will they have money in savings to fix the problem? No, they won’t. They will go into debt thus the downward spiral continues. Maybe we should start at the grade school level and teach kids about money. How to make a budget, manage debt, save for retirement. Most kids only know how to use their ATM card and check their balance online. I challenge you to ask a millennial if they balance their checkbook (or know how).”

 

On the topic Robert Schwartz contributes, “I know that a lot of talk of late has revolved around the issue of 97% LTV loans. I wanted to share with you a backgrounder from the U.S. Mortgage Insurers (USMI) on this very issue. Hope that as you continue to write on the issue this document will be helpful.”

 

Continuing on with the down payment theme, I received this note from Murray Gray with Grace Financial Network. “In reading comments from those defending the initiative to help those without the means to save at least 5% for a down payment, I would agree with them that down payment by itself is not an indicator or ability to pay. But I will add that in retrospect the statistics clearly show that comparing the default rate of those home owners with little or no down payment, there was no difference in the default rates between the 800 score borrower and the 550 score borrower. (The stats on the default rates of the 800 and 500 credit score borrowers being virtually identical were from Congressional hearings I was watching on Washington Mutual back in 2006.) I have no doubt that those making the push are politically motivated and not truly in the best interest of the health of the economy and the United States. The statistics are out there and one can try to spin it any way they want but just once I would like to see common sense to prevail and let the statistical documentation that is available and so abundant to help steer our course going forward.

 

The old saying about skin in the game is all too true. With the four components of a loan being income, credit, property an funds taking the skin out of it makes the rest of the loan a far greater risk than say a 50% no doc loan, there are simply a number of other type loan products that could and should be reintroduced but in this current political environment those aren’t cool. I would rather move beyond the politics that favor the little or no down payments and put on our common sense hats and admit that a 100% no doc low credit score, interest lonely investment loan was about as irresponsible. But show me the default rate on a 50% no doc, interest only loan and I will show you a good loan. Interest only and no doc loans were never the culprits. It was the other irresponsible loosening of the guidelines for these products that made them bad loans.”

 

Speaking of LTVs and credit, Freddy Martino sent in, “Whitney Fite, SVP, managing director of Angel Oak Home Loans LLC, recently made some comments on current misperceptions surrounding homeownership that were highlighted in a survey conducted by Wells Fargo. Whitney notes how these misperceptions could be impacting individuals’ drive to purchase a home. ‘With the affordability index holding at such a high level, individuals with even modest incomes can obtain a loan. The fact that 74% of the respondents feel they know and understand the mortgage process is certainly misaligned with the findings that 30% think only individuals with high incomes can obtain a loan. According to this survey, 44 percent of potential homeowners also believe that a 20 percent down payment is still required to secure a loan. In reality, there are many options available with as little as 3.5%-5% down payment required.’

 

“Further, he goes on to appeal to American’s that are actively looking to purchase a home that their fears based on market conditions and the mortgage process are mostly ungrounded. “Interest rates remain low, values continue to improve, and credit requirements to obtain a mortgage continue to loosen. Collectively, these factors have yielded high loan application approval rates. Prospective borrowers should educate themselves through a trusted mortgage advisor when considering buying a home.”

 

Switching topics to marketing effort and energy, David Oldenburg observes, “Rob, I wanted to throw in my 2 cents regarding the LO and the ‘helping’ the Realtor pay for their marketing. This has been going on since the beginning of the industry, which is why RESPA was created in the first place over 30 years ago! The loan officer is lucky. Many agents don’t ask for help marketing, they go straight for your commission, and will leave you if you don’t agree. I know of multiple LOs in the Sacramento area who give as much as 50% of their commission in ‘cash’ for every loan referral. I spoke to one LO last year who gives a set dollar amount for every referral to a Realtor, and on one low loan amount, the agent made 75% of the commission and the LO made 25%…nice! RESPA is worthless and there are thousands of under the table deals going on each day.

 

“I would tell the LO to turn the agent in, but I know of LOs who have done that and they are still waiting and nothing has ever happened. My advice to the LO? It takes the same amount of time, energy and effort to market and network with attorneys, CPAs, financial advisors, doctors, etc…I quit marketing to Realtors almost 20 years ago and now they need me and my skills more than I need them. Some LOs might think they should just comply and take the easy road and pay the agent. That way they at least get the referrals. Two points. First, I knew an LO who agreed to pay 25% of his commission in cash for each deal the Realtor referred. This worked and everyone was happy. Then, one night at a mixer, the Realtor met a lender who agreed to pay 50%. My friend lost the Realtor. All of that work, energy, loyalty etc…, gone in an instant. Second, if you instead take 25% or 50% of your commissions and use it for some serious marketing to other referral partners, you will not need to pay anyone a part of your money, you will have a great write-off, and you will be completely legal…just saying!”

 

“Rob, I run production for a small bank in Missouri. I’ve asked my CFO for information on how, if at all, Basel III is going to impact us, but with little response. Do you have anything simple?” I will take a stab at it, but bank officers should consult with accountants and other advisors. Basel III must be implemented on Jan 1, 2015. This restructure of bank capital incorporates many changes. Remember that the overriding objective of Basel III is to require banks to have more and better quality capital. Basel III applies to nearly all US financial institutions (although those with >$250B in assets have much more stringent requirements). But community banks will also be impacted.

 

The implementation of Basel III will come in two phases with new capital requirements, changes in risk weightings, the grandfathering of eligible non-qualifies instruments and the AOCI election effective 1/1/2015. The second part of the law, the phase-in of the capital conservation buffer, begins on 1/1/2016. To focus on the immediate concerns, the new definitions of regulatory capital and compliance with new minimum risk-based capital ratios require some new thinking (primarily because there are new risk weightings for some instruments). Risk Based Capital is calculated by dividing total regulatory capital by risk weighted assets, so changes to risk weightings under Basel III take on great importance. For risk weightings, note there will be no changes for many categories of loans and securities and that is good. But there will be a 150% risk weighting for CRE that is identified as high volatility, or HVCRE. This category is defined as all acquisition, development and construction (ADC) commercial real estate loans, with some exceptions. The exceptions are: 1-4 family residential ADC loans or CRE ADC loans that meet applicable regulatory LTV requirements and loans where the borrower has contributed cash of at least 15% of the real estate’s “appraised as completed” value (and the borrower’s capital remains in place until the project converts to permanent financing, is sold, or is paid in full). Everything else that falls under HVCRE will be risk weighted at 150%, where under current rules those loans would be risk weighted at 100%. I am not going to list the weighting for things like non-accruals, revenue bonds, single issuer trust preferreds, past-due loans, commercial (real estate, C&I, and agricultural) and consumer loans.

 

Basel III’s emphasis on risk weighting is a regulatory expression of a desire for banks to operate with capital positions well above minimum risk-based levels. The goal is to have “cleaner” capital and for banks to hold capital commensurate with the level and nature of the risks to which that bank is exposed. For more detail and itemized risk weighting, check this out.

 

 

A Priest was about to finish his tour of duty, and was leaving his Mission in the jungle where he has spent years teaching the natives, in their language, when he realizes that the one thing he never really taught them much was how to speak English.

So he takes the chief for a walk in the forest. He points to a tree and says to the chief, “This is a tree.”

The chief looks at the tree and grunts, “Tree.”

The Priest is pleased with the response.

They walk a little further and he points to a rock and says, “This is a rock.”

The chief looks and grunts, “Rock.”

The Priest was really getting enthusiastic about the results when he hears a rustling in the bushes.

As they peek over the top, he sees a couple of natives in the midst of heavy sexual activity.

The Priest is really flustered and quickly says, “Man riding a bike.”

The chief looks at the couple briefly, pulls out his blowgun and kills them both.

The Priest goes ballistic and yells at the chief that he has spent years teaching the tribe how to be civilized and be kind to each other, so how could he kill these people in cold blood that way?

And the chief replied, “My bike.”

 

 

Rob

 

(Copyright 2014 Chrisman LLC. All rights reserved. Occasional paid job listings do appear. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Rob Chrisman.)