July 16: Notes on the future of the FHA, fair value accounting on pipelines, & broker comp changes after the LE is provided
Recently, I received a question about whether, under Regulation Z, a broker can lower the compensation he receives from a consumer in connection with a mortgage loan. (Seems like a no-brainer: how could the law prohibit charging a consumer less?) Specifically, I was asked if the broker’s compensation can be reduced after the TRID Loan Estimate (LE) has been provided to the consumer, if the consumer has not locked his/her interest rate. The reason stated is simple: brokers want to match competitors’ pricing offers.
I did some digging and here is what I found: I spoke with an attorney who advises lenders about the Regulation Z loan originator compensation rules. Those rules prohibit tying an originator’s compensation to the terms of a loan. The attorney, who advises large wholesale lenders, pointed to a part of the Commentary to Regulation Z and stated that the law also could read to prohibit changing an originator’s compensation (either up or down) once a lender provides the TRID LE. (The magic wording in the Commentary states that “when the creditor offers to extend credit with specified terms and conditions” the amount of compensation cannot change, either increase or decrease, for example, due to negotiating pricing to match a competitor.) One can debate whether the TRID LE qualifies as an offer to extent credit with specified terms. After all, the estimates are just that – estimates.
The attorney, however, also stated that he recently had a discussion with CFPB staff, who stated that compensation could not change once the TRID LE is provided — even if the consumer has not locked the interest rate and even if the compensation will be lowered, for example, to match a competitor’s price. In addition, the attorney relayed the CFPB staff view that compensation cannot be changed (after the TRID LE is provided) even if the price of the loan will increase, due to, for example, a higher LTV ratio, lower FICO score, or assessment of additional fees for inspection.
Switching gears to the ebb and flow of residential loan volume, plenty of companies have swollen pipelines, and may be worried about warehouse constraints later in the month.
According to research presented by Andy Greer of First Tennessee Bank, the adoption of Fair Value Accounting for pipeline loans has dramatically overstated income and assets in the financial statements of most mortgage bankers. Fundamentally, Interest Rate Lock Commitments (IRLCs) should never be more valuable when they are IRLCs than when they become closed loans. Most valuation formulas in use by industry professionals, however, yield this erroneous result. Greer, a CPA and warehouse lender with First Tennessee, has examined the non-existent market for IRLCs, the expected cash flows necessary to turn an IRLC into cash, the concepts of direct vs. indirect costs, and the authoritative and interpretative accounting guidance on the topic.
Put another way, since warehouse issues are always a concern of independent mortgage lenders, as mortgage originators’ loan pipelines swell due to record-low rates, the derivative asset termed interest rate lock commitments (IRLCs) associated with these pipelines has also grown on their balance sheets. This asset’s current accounting treatment by many mortgage originators reflects a calculation of the gross revenue anticipated from the sale into the secondary market of the loans represented by the IRLCs minus “direct costs” to arrive at the pipeline’s fair value. Greer’s paper observed deductions of between one third and one half of the observable costs needed to convert the lock into a saleable loan, even considering already-incurred costs. Some auditors and originators justify these limited deductions by claiming that a buyer of the IRLCs in a fair value transaction would not consider all of the future costs, such as fixed costs, of the originator.
His findings will be presented briefly in a discussion titled “Sasquatch, Nessie, and Interest Rate Lock Commitments: Myth versus Reality” on Tuesday, July 26, 2016 at 4:30PM in the “Square” at the CMBA’s Western Secondary Marketing Conference. Andy would also like to meet with any CPAs, CFOs, or other interested parties on the same Tuesday prior to the 4:30PM discussion and has reserved a conference room to do so. Please contact Andy at firstname.lastname@example.org to obtain a full copy of the paper on this subject and set up a meeting time. (Andy can also be reached at 901-759-7705. Andy is a CPA & warehouse lender with First Tennessee Bank.)
This week I posted a note about how a hike in the minimum wage was leading to companies like McDonalds & Wendy’s moving toward automated kiosks rather than humans. This note came through my e-mail. “Low military pay was not mentioned in the last State of the Union speech. Just increasing the minimum wage was.
“For those fast food employees striking for $15 an hour, let’s do some math. At $15 an hour Johnny Fry-Boy would make $31,200 annually. An E1 (Private) in the military makes $18,378. An E5 (Sergeant) with 8 years of service only makes $35,067 annually. So you’re telling me, Sara McBurgerflipper, that you deserve as much as those kids getting shot at, deploying for months in hostile environments, and putting their collective butts on the line every day protecting you? Here’s the deal, Baconator, you are working in a job designed for a kid in high school who is learning how to work and earning enough for gas, and hanging out with their equally goofy high school pals. If you have chosen this as your life long profession, you have failed. If you don’t want minimum wage, don’t have minimum skills. If you can read this, thank a teacher. If it’s in English, thank a Veteran.”
What is the role of the FHA? Patrick Sinks with MGIC wrote, “Rumors have started, and positions are being put forth that the Federal Housing Administration (FHA) should reduce its premiums yet again. This is the wrong thing to do on many levels. The FHA often has said it has twin purposes, 1) to serve as countercyclical capital particularly during times of regional or national economic stress and 2) to facilitate homeownership for low and moderate income families. Let me address each.
“The housing market is well on its way to recovery. There is no need for government action in the form of providing countercyclical capital that is necessary at this point in time. There are many statistics that support that this recovery is well in place. In fact, over the past couple of years the various leaders of Housing and Urban Development (HUD) and the FHA have stated that with a recovery in mind they would hope that the FHA’s percent of the insurable residential mortgage market should return to its historical levels. The FHA’s share of the insurable market has not returned to its historical levels and, in fact, the FHA market share has increased since its January 2015 premium rate cut.
“In regard to facilitating homeownership, the FHA’s mission is to assist underserved households to attain affordable homeownership. Presently, the FHA is straying from that mission. According to the 2014 Home Mortgage Disclosure Act data, 42% of FHA borrowers earn greater than the area median income (AMI). Additionally, the FHA claims that approximately 20% of their purchase volume comes from repeat buyers. These borrowers likely have private sector alternatives that would not further expose US taxpayers. The GSEs and the state HFAs ensure they are targeting the appropriate borrowers by enforcing AMI limits and/or first-time home buyer restrictions on their affordable programs. The FHA should do the same to ensure it stays squarely focused on the households with the greatest need.
“It has been reported that the recent volume insured by the FHA has credit scores greater than 700 more than 30% of the time. The question has to be asked why the United States Government and we as taxpayers are providing insurance to borrowers with strong credit profiles. This is hardly the mission-driven segment of the market the government needs to support. The private sector is perfectly suited and equipped to serve that market, thus reducing taxpayer risk.
“In many respects the GSEs, representing the conventional market and the FHA representing the government are competitors in the high LTV space. Within the last couple of years, the GSEs re-entered the 97% LTV market with hopes of providing greater access to credit supported by private capital, such as private mortgage insurance. One effect of this would have been moving business from the FHA to the GSEs. Shortly thereafter the FHA announced a significant premium cut (37%) which for all intents and purposes muted the impact of the GSE programs. The significance of this is that the FHA insurance covers 100% of the loan balance for the life of the loan. On the other hand, on loans with LTVs greater than 80% the GSEs are required to have credit enhancement, most often in the form of private mortgage insurance. The GSEs’ exposure is typically the bottom 70% of the loan, making losses to them more remote, and, in contrast to FHA’s 100% exposure to loss. So, in effect, the FHA move, while intended to provide additional access to credit, worked against the GSE/private capital program, and caused the exposure for loss to move from the private sector (PMI) to the taxpayer.
“In addition, the GSEs have been directed by their regulator, the Federal Housing Finance Agency (FHFA), to reduce their mortgage credit risk even further. Over the last couple of years the GSEs have been doing what is known as risk sharing transactions the goal of which is to further de-risk the GSEs and in turn reduce taxpayer exposure. Any reduction in FHA premiums will in effect mitigate that goal by moving business from the GSEs/private sector to the government/taxpayer. These are contradictory actions by our government. In fact, it is crazy housing policy but that is a subject for another blog.
“Should the FHA feel the need to reduce premiums further (which I obviously think is not warranted) it should be 1) limited to FICOs below 680 where the FHA can truly fulfill its mission and/or 2) establish a median income test based on MSA. Further, the program should also be limited to first-time homebuyers. There is no reason why someone making an income in excess of AMI with a FICO score greater than 700 should be turning to the government for assistance. And, that is certainly true when one looks past the FHA and realizes the FHA equals taxpayers.
The FHA actuarial report is due for its annual update in November. Given the general quality of loans being originated today, it is reasonable to expect that the Forward Mortgage component of their capital will improve, perhaps even coming in above the 2% minimum capital requirement. A 2% minimum capital level (a 50:1 leverage ratio) is inadequate, particularly when you consider that the private mortgage insurers hold minimum capital equal to approximately 7% (a 14:1 leverage ratio). In addition, as I have stated, the FHA insures loans for the life of the loan. Just because things may look better today does not mean that they will look good a few years down the road or when the next recession will occur. They need enough capital to cover many economic scenarios over various cycles and 2% at a point in time is woefully inadequate as the Great Recession proved. If the FHA reduces premiums again, and uses the same 2015 premium reduction talking points, they will likely say they are providing access to homeownership to thousands of more borrowers, and that this premium reduction will not impact capital because of the additional premiums generated by new homeowners. That is a “make it up in volume” strategy, using taxpayer dollars. That is not sound housing policy.
“In summary, there is no justifiable reason for the FHA to consider reducing its premiums without first addressing its role. The market is well served by the private sector during these better economic times. And further, doing so actually increases taxpayer exposure, a situation no one should favor.”
Jacob, age 92, and Rebecca, age 89, living in Miami, are all excited about their decision to get married. They go for a stroll to discuss the wedding, and on the way they pass a drugstore, Jacob suggests they go in.
Jacob addresses the man behind the counter: “Are you the owner?”
The pharmacist answers, “Yes.”
Jacob: “We’re about to get married. Do you sell heart medication?”
Pharmacist: “Of course, we do.”
Jacob: “How about medicine for circulation?”
Pharmacist: “All kinds.”
Jacob: “Medicine for rheumatism?”
Jacob: “How about suppositories?”
Pharmacist: “You bet!”
Jacob: “Medicine for memory problems, arthritis and Alzheimer’s?”
Pharmacist: “Yes, a large variety – the ‘works’.”
Jacob: “What about vitamins, sleeping pills, Grotto, antidotes for Parkinson’s disease?”
Jacob: “Everything for heartburn and indigestion?”
Pharmacist: “We sure do.”
Jacob: “You sell wheelchairs and walkers and canes?”
Pharmacist: “All speeds and sizes.”
Jacob: “Adult diapers?”
Jacob: “We’d like to use this store as our Bridal Registry.”
(Copyright 2016 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.)