Jan. 21: Notes on pipeline hedging, condo reserve funds, fines for lack of cybersecurity, HECMs, and appraiser training & education

Yesterday’s FHA MIP reversal was expected, yet investors and operations personnel had to move quickly. When one talks to appraisers you hear a lot of stories about insects and rodents, which also tend to move quickly. Philadelphia has the dubious honor of leading the nation in reported evidence of rodents (18% of households), the largest percentage among the 25 U.S. cities broken out in data from the latest federal American Housing Survey. Cockroaches? New Orleans, Houston and Miami topped the list of infested cities.


Delving into mortgages, I received this note from a concerned acquaintance. “My friend owns a condo near Galveston. She says that because the condo association does not have a reserve fund, a new buyer will not be able to get a Fannie or Freddie-backed mortgage and will instead have to get a nonconforming loan. True?”


Darned if I know, as I am not an underwriter or expert on Agency policy, but I have it on “good authority” that “it depends.” In the guidelines, you may find something to the effect that when a full project review is required, Fannie Mae requires that the lender obtain the HOA budget to evaluate the sufficiency of the condo association’s reserve fund and confirm that the HOA is budgeting at least 10% of its income from dues to be set aside for the reserve fund. If the association is budgeting less than 10% of its income for the reserve fund our policy provides flexibility for the lender to obtain a reserve study to confirm that the project is sufficiently reserving for future needs without having to hit the 10% threshold.


When a limited review is completed, Fannie Mae does not require a budget evaluation though some lenders may still choose to confirm that the project is financially sound. Investment transactions, new projects consisting of attached units, and transactions in higher LTV ranges are not eligible for the limited review process. And my guess is that Freddie Mac’s requirements are substantially similar to Fannie’s and that FHA always requires a reserve analysis for project approval.


Although the decline in volume has removed some of the heat appraisers have felt in certain areas of the nation, the appraisal segment of lending continues to evolve and be subject to input and thought. This is especially true of appraiser training, and bringing new blood into the business. (For example, on-the-job training prior to being licensed in Colorado and Wisconsin? Nah.) Mike Simmons, co-president of Axis Appraisal Management, sent, “Rob – I read the commentary on the business model and economics of appraising from Tom Allen in a Saturday column of yours a while back. While I know Tom – and like him – I want to take issue with a couple of the points he made, but at the same time I want to help support his goal to leave appraising better off than when he started.


“To begin with, if all it took were to raise appraisal fees to $700, then states like Oregon, Washington and Colorado wouldn’t continue to be a nightmare from a service standpoint. Fees are only one element of the problem. Raising fees won’t solve for a ‘limited resource’ (corporate speak for a shortage of appraisers) to meet changing and growing marketplaces. Well, ultimately it might solve the problem, but that’ a five to nine-year arc; 2 years interning as a Trainee to meet the requirements to sit for testing to become a Licensed Appraiser and then additional hours (and testing) to earn a Certified License.


“And after that, nearly every lender and investor requires at least another 3 years of experience before they’ll accept reports that aren’t signed by a supervising Certified appraiser. Let’s not forget that prior to all that, a candidate needs to have acquired a 4-year college degree. By the way, that’s a degree in any field of endeavor … and I’m not aware of any place that gives a diploma in appraising. As a footnote: a college degree is not required to practice law, get a Series 7 License to sell securities, not required to sell Life Insurance (or insurance of any kind) and a number of other fields that serve the public trust. Nor is a degree required to be a Realtor or Mortgage Loan Originator. One may only need to take and pass some industry specific courses and pass a test related to that field of endeavor.


“The solution lies in a series of changes; higher fees for one to attract the best candidates to become appraisers, modifying the barriers of entry to the profession of appraising (without sacrificing the caliber of experience-based training) is another, improving the quality and content in appraisals through enhanced technology and a deeper understanding of data, and a continuing belief of the valued role collateral plays – and how that all hinges on appraisers being independent and free from any type of coercion.


“There are a great deal of folks working on different pieces of this problem. The Appraisal Foundation is re-examining the role of education, experience and training. At one appraisal-centric industry organization (the Collateral Risk Network), we’re looking at what role we can play in helping to resuscitate a true training program for a new generation of appraisers. The other day, the Chief Appraiser for one of the largest banks in the country said to me that the mantle of leadership around guiding and growing future appraisers had shifted from the Banks to the AMCs. I think that’s correct.


“I also think we need to find ways to incorporate banks ‘tribal knowledge’ and experiences. We’ll also need to add the voices of the other stakeholders (NAR, MBA, IMB, and the other vendors that serve the real estate industry) to help the states modify their regulations to better serve and protect their constituents.  Big jobs all – but these are challenges we urgently need to address. The real estate industry is a giant piece of our American economy and, at its core, sits a fundamental trust that an independent expert – an appraiser- is translating the complicated elements that define value that will protect both the consumer and those that supply the capital to make home ownership possible.” Thanks Mike!


Recently the commentary discussed reverse mortgages and I received this note from a veteran broker in Nevada. “Touching on HECM loans. I have done a few HECM refis. It was a great program to help seniors stay in their homes. I bailed 2 different individuals out of Wells foreclosure with a HECM. I have also done 1 HECM purchase. That was a nightmare…like an FHA purchase loan on steroids. The new rules (a year ago or so) have changed the program to focus on retirement income, rather than keep your home. The qualifying is very tedious. Things like prove payment of HOI and prop tax for the last 2 years – but the same income and asset verification as standard FHA loan. There is NO reason anyone obtaining a HECM would not understand they must pay prop tax and HOI and continue to maintain their property as they have in the past.  If some are confused and/or deceived they are involved in on-line loan with no contact to a real person. As with any loan, if borrowers work with a live person, they receive information. At least they do with me.”


If you’re a CEO or owner of any financial services company, and haven’t given cybersecurity even a passing thought, you should. Finra handed down $14.4 million in fines to a dozen firms for breaches related to the retention of broker-dealers’ and customers’ electronic records, which the brokerage industry watchdog claims made the firms vulnerable to cybersecurity threats. Finra claims the firms (which includes the Wells Fargo & Co. and RBC Capital networks, RBS Securities Inc., SunTrust Robinson Humphrey Inc., LPL Financial, Georgeson Securities Corp. and PNC Capital Markets) didn’t keep electronic records in a particular format meant to prevent alteration and destruction.


Companies of Wells Fargo & Co. were hit with the largest aggregate penalties, a total $5.5 million. Wells Fargo Securities and Wells Fargo Prime Services were jointly fined $4 million, while Wells Fargo Advisors and Wells Fargo Advisors Financial Network were fined $1.5 million. The firms neither admitted nor denied the charges as part of the settlement reached with the Financial Industry Regulatory Authority Inc., the industry-funded broker-dealer regulator.


“These disciplinary actions are a result of Finra’s focus on ensuring that firms maintain accurate, complete and adequately protected electronic records,” Brad Bennett, Finra’s chief of enforcement, who is stepping down from his post early next year, said. “Ensuring the integrity of these records is critical to the investor protection function because they are a primary means by which regulators examine for misconduct in the securities industry.”


The multimillion-dollar fine is in line with Finra’s broader crackdown on cybersecurity lapses, which it outlined as a regulatory and examination priority. Each of the 12 firms fined had “deficiencies” in their WORM — or “write once, read many” — format affecting millions, in some cases hundreds of millions of “pivotal” records, per Finra. WORM format is required for business-related electronic records under federal securities laws and Finra rules because it’s meant to prevent alteration and destruction of those records. “Increasingly aggressive attempts” by hackers to gain access to sensitive financial data pose a threat to “inadequately protected records,” per Finra.


Shifting gears to another type of risk, Dean Brown, CEO of Mortgage Capital Management, penned, “Top 5 Pipeline Management Mistakes Made Since the Election.”


“Bad Hedge Ratios: Using Regression based or linear Duration Based hedge ratios. In some cases, the regression approach resulted in an average loss attributable to incorrect hedge ratios after the large down price movement of approximately 3 points after the election. For example, if $100 million of FNMA 3.5 coupon based loan product was hedged with FNMA 3.0 coupon TBA’s (using the before election regression based hedge ratios) a loss of 45 basis points or $450,000 would have been incurred and will soon be realized given the 3 point drop in the market and a 15% error in hedge ratio.”


Number 2 is “Static Fallout Estimates: Employing an inaccurate Fallout model or using static fallout assumptions during the period. For example, if your pre-election fallout model used a fallout rate of 25% and continued through the 3-point change in the market and your average actual fallout went down to 15% during the period, your expected loss due to inaccurate fallout assumptions would total $300,000 based on the 10 percent under hedged pipeline.


“No Option Coverage: Not using options to hedge the expanded exposure to the pipeline due to decreased fallout.  For example, when the market has large moves downward – something that has not happened for a long time, more loans closed than usual because borrowers are more motivated to provide documentation and get the rate they locked in. Also, they have a harder time finding a lower rate somewhere else. The increased exposure from higher closing rates and market volatility would have also increased pipeline hedging costs. Both of which need to be accounted for by employing the correct amount of Put option coverage. In the future, increased volatility will cause losses for those not using put options by having the tail wag the dog and being whipsawed from pairing out and selling after adverse market movements.


“Old Pricing Levels: Pricing loans based on old or in some cases less than updated pricing for new locks. Many firms use best efforts based pricing in their automated loan pricing systems. These pricing levels are meant to be indications of where an investor would purchase the loans at the time they are posted. Not a guarantee that they will in the future. In many cases over the last month these levels were old at the time locks were taken – in many cases by a significant amount because the market had deteriorated and the best efforts based prices had not been updated.”


Dean wrapped up with #5: “Underestimating Locks: Taking locks after the market had closed for the day and not anticipating the volume of loans that needed to be covered before the market closed for the day.  In a market that gaped down many times at opening i.e., before trades could be put on for the day additional losses would have been incurred. For example, if the amount of new locks anticipated from overnight locks was $5 million on a given day and turned out to total $10 million and the market sold off a point before the market opened for the day a loss of $50,000 will eventually be recognized.”



(There must be an analogy here in mortgage lending.)


Bob: “I took a big fall, fell off a 50-foot ladder.”

Jim: “Oh wow, are you okay?”

Bob: “Yeah, it’s a good thing I only fell off the first step.”






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Rob Chrisman