Sep. 9: Compliance & regulation news; capital markets deals; thoughts on the current climate for lenders

Good morning from Birmingham, Alabama! (I had a great dinner at Hot and Hot Fish last night, so thank you to Arch MI’s Kris S. for the recommendation.) Like many other parts of the United States, home prices are doing well here. Alabama’s median sales price increased to $228,030, achieving the highest median sales price recorded this year. Here’s some more fun with numbers… Walmart lowered the starting wage for new hires in some of its stores. Current workers’ pay and the retailer’s $14 per hour minimum wage will remain unchanged and continue to vary by region. Did you know that every year, about 330 million tennis balls are produced, most of which end up in landfills where they’re anticipated to take centuries to decompose? The U.S. Open goes through about 100,000 balls over the course of the tournament! But let’s return to talking about mortgage banking.

Thoughts on the current climate for lenders

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From out in California, industry vet James Johnson opined, “On the surface, my commentary will sound pretty negative. But that is not my intention. I will conclude with how the market for IMBs will improve.

“We had a 40-year bull market in bonds (1981-2021). By definition, that had to end at some point, and it did just that in 2021. During this 40-year period the mortgage banking industry ballooned up to a scale that is clearly unsustainable. Total volume in 2019 was just over $2 trillion. Capacity at year end 2019 was probably around $2 trillion, maybe a little less. Then volume jumped to $4 trillion in 2020, almost double capacity at the start of the year. Of course, this led to an enormous expansion of margins and IMBs were overwhelmed with volume. Profits were unprecedented.

“Then capacity climbed steadily in 2020 and probably peaked in late 2021 at around $4 trillion. But volume in 2021 was about $4.5 trillion, still in excess of capacity, which allowed margins to remain wide throughout the year, but not nearly as wide as 2020. Fast forward to 2022 and volume was around $2.75 trillion. But capacity was $4 trillion to start the year, so a huge capacity overhang.

“Ever since late 2021 or early 2022, the industry has battled way too much capacity. My best guess is that capacity is around $2 trillion right now, but volume will be about $1.5 trillion for 2023. There is still way too much capacity on a percentage basis, and this has caused margins to remain very compressed.

“The Great Rest I mention is a recalibration to an industry of far different scale that we saw in 2020 and 2021. There is not another $4 trillion year out there. There is probably not another $3 trillion year any time soon. The industry that many thought could sustain $4 trillion volume is really a $2 trillion type industry. You can use a range of $1.5 trillion to $2.5 trillion. This is a totally different industry that we had a couple of years ago. But this is the likely reality for some time.

“What does the Great Reset mean for IMBs? It means very few refis, tightly compressed margins, and an operating scale that makes life extremely difficult for all companies, especially the smaller ones. This is all pretty obvious.

“How does the industry get out of this mess? This will be resolved one of two ways. First, capacity could fall to something around $1.5 trillion to come into balance with today’s volume. That is very unlikely. Capacity is too sticky. For sale capacity to drop to the $1.5 trillion level, the entire bottom 50% of producers would have to exit the industry. That is not going to happen. If it did, it would take another 2-3 years.

“The second option is for volume to jump up to $2 trillion, matching today’s capacity. That could happen for sure, and a much more likely solution. Mortgage rates would need to get to 5.5 percent. and probably 5 percent to generate enough refis to get volume up to $2 trillion. We probably have about $1.5 trillion in 6-7 percent loans closed right now that could become refi candidates. By Q-3-24 that 6-7 percent pool will be closer to $2.5 trillion, maybe a little more. At 5 percent mortgage rates the industry might be able to refinance 20 percent of the high coupon pool, generating an additional $500 billion in volume. That would take us to $2 trillion.

“Next question, how do we get to 5 percent Right now 30-year fixed is yielding almost 300 basis points over the ten-year Treasury. That spread was as low as 175 basis points when the Fed was buying all of the MBS. If the ten year gets down to 3 percent, that spread will shrink to something like 250 basis points, maybe a little less. That is how rates get to 5.25% or 5.5%. something like that. There is no silver lining, rates must drop like I suggest above.

“Yes, IMBs are at the mercy of interest rates, no way around that. I’m in the camp that something bad is going to happen and force the Fed to drop rates. This month is the 25th Anniversary of the implosion of Long Term Capital Management. The Fed bailed everybody out back then, and over the last 25 years they have only missed one bailout opportunity. That was Lehman Brothers and the Fed and US Government regret that decision. The Fed bailouts are not over and I’m expecting to see them again as soon as we get some sort of shock. I can’t give you odds on this playing out as I suggest. Barring something like my scenario, there will be massive failures with IMBs. Hopefully what I suggested happens in the next 12 months while companies are still solvent.” Thank you, James.

Compliance and regulatory actions in residential lending

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Mortgage Quality Compliance and Research recently released a hot topic on recent trends in mortgage fraud schemes and mortgage fraud prevention tips. Lenders should remain diligent and continually look out for ways to improve fraud detection and prevention controls given the unique financial pressures of the current market. Fannie Mae advised lenders they may strengthen their fraud detection and actively combat mortgage fraud by leveraging their quality control (QC) program to reinforce fraud controls and prevent fraud before it starts. Fannie Mae maintains a dedicated Mortgage Fraud Prevention webpage, which provides valuable resources including publicly available data on fraud trends and recent fraud alerts.

Mortgage Quality Management and Research recently released a note on appraiser independence requirements. A Fannie Mae approved mortgage lender may not permit a mortgage loan originator (MLO) or mortgage broker to choose the AMC from a list of its approved AMCs from which to order an appraisal. Permitting sales and production staff to be involved with appraisal ordering violates Fannie Mae’s Appraiser Independence Requirements (AIR). AIR indicates “[t]here must be separation of a Seller’s sales or mortgage production functions and appraisal functions. An employee of the Seller in the sales or mortgage production function shall have no involvement in the operations of the appraisal function” (emphasis added). Selecting the AMC constitutes having involvement in the appraisal function and provides the MLO/broker with an element of responsibility for selecting or retaining the appraiser. Additionally, a lender may not order an appraisal by directing a broker to select an AMC from among a group of specifically authorized AMCs, one of which would receive information from the broker about the loan application and begin the appraisal process. Such a process would give the broker an element of responsibility for selecting or retaining the appraiser, and therefore would not be compliant. A lender may direct a broker to an authorized AMC if the lender has previously arranged for its appraisal process to be managed by the specifically authorized AMC. This process is compliant with AIR because the broker is not responsible for selecting, retaining, or providing for payment of compensation to the appraiser.

Jonathan Foxx, Ph.D., of Lenders Compliance Group recently opined on what to do if your company is hacked. If your company experiences a data breach, you should notify law enforcement, other affected businesses, and individuals. Do not destroy evidence, and have an immediate response, including securing physical areas potentially related to the breach. Stop data loss and remove web vulnerability. Whatever steps you take procedurally, be sure to ask your forensics experts and law enforcement when it is reasonable to resume regular operations.

Orrick reported that, “On September 1, California Attorney General (AG) Rob Bonta announced a settlement with a mortgage servicer for its alleged failure to properly process and grant mortgage deferment requests from California military reservists called to active duty. California’s Military and Veterans Code, which includes the California Military Families Financial Relief Act, allows reservists to delay paying mortgages, credit cards, property taxes, car loans, utility bills, and student loans. To defer payment, they must submit a written request and their military orders to the entity to which their payments are due. The AG noted that the California Department of Justice investigated the mortgage servicer’s processes for handling mortgage deferment requests and found that the servicer delayed granting the deferment requests, requested information for eligibility review outside of the 30-day timeframe to do so, and improperly denied deferment requests, on at least 10 occasions. Furthermore, the servicer allegedly attempted to collect payment from some borrowers during the requested deferral period by making calls and sending notices that warned that the servicer would foreclose on the borrowers’ properties if they failed to pay.”

Also posted was a note about the CFPB posting guidance to its website that affirms guidance on the Real Estate Settlement Procedures Act (RESPA) that the Department of Housing and Urban Development previously issued. In 2011, the Dodd-Frank Act transferred responsibility for RESPA from HUD to the CFPB.

The secondary markets drive primary market rates for borrowers

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Here’s some deep background for any capital markets nerds out there. As you know, we are in the business of giving free options to borrowers. Put another way, they will close the loan with a lender. Or not. And often this decision is based on the loan price compared to the market, which changes every day, and sometimes throughout the day.

At the base of every hedging model is a lattice. A lattice-based model is used to value derivatives by employing a binomial tree to compute the various paths the price of an underlying asset, such as a stock, might take over the derivative’s life. A binomial tree plots out the possible values graphically that option prices can have over different time periods. And the free option that lenders give borrowers in the form of a rate lock, which in some cases can be renegotiated, certainly has a value. So, a lattice-based model is used to value derivatives, which are financial instruments that derive their price from an underlying asset. And lattice models employ binomial trees to show the different paths the price of an underlying asset might take over the derivative’s life.

Lattice-based models can take into account expected changes in various parameters such as volatility over the life of the options. Volatility is a measure of how much an asset’s price fluctuates over a particular period. As a result, lattice models can provide more accurate forecasts of option prices than the Black-Scholes model, which has been the standard mathematical model for pricing options contracts. And now you know!

In capital markets news, the home for most FHA & VA loans continues to expand. Ginnie Mae’s mortgage-backed securities (MBS) portfolio outstanding grew to $2.458 trillion in August, including $38.1 billion of total MBS issuance, leading to $18 billion of net growth. Issuance for this month was approximately the same as July’s $38.0 billion but lower than June’s $39.5 billion.

This follows news from the prior month. Ginnie Mae mortgage-backed securities portfolio outstanding reached $2.440 trillion in July. Issuance for this month was lower than June’s $39 billion but higher than May’s $34 billion and April’s $33 billion. July’s new MBS issuance supports financing for more than 120,000 households, including more than 57,000 first-time homebuyers.

And Ginnie Mae’s mortgage-backed securities (MBS) portfolio outstanding grew to $2.422 trillion in June, including $39 billion of total MBS issuance, leading to $18 billion of net growth. Issuance for this month was significantly higher than May’s $34 billion as well as April’s $33 billion. June’s new MBS issuance supports the financing of more than 130,000 households, including more than 62,000 first-time homebuyers. Approximately 75 percent of the June MBS issuance reflects new mortgages that support home purchases, as refinance activity remained low due to higher interest rates. For the 2023 calendar year to date, Ginnie Mae supported the pooling and securitization of more than 294,000 first-time homebuyer loans. The June issuance includes $37.9 billion of Ginnie Mae II MBS and $1.3 billion of Ginnie Mae I MBS, including approximately $1.2 billion in loans for multifamily housing.

Private label securities continue to dribble out. For example, Janney managed the issuance of $315 million of non-QM mortgages by AmWest Funding. The securitization has a weighted average original credit score of 738, a weighted average original loan-to-value ratio of 67.5%, and a weighted average original debt-to-income ratio of 37.8%.

Fannie Mae priced Connecticut Avenue Securities (CAS) Series 2023-R05, an approximately $738 million note offering that represents Fannie Mae’s fifth CAS REMIC transaction of the year. CAS is Fannie Mae’s benchmark issuance program designed to share credit risk on its single-family conventional guaranty book of business. With the completion of this transaction, Fannie Mae will have brought 58 CAS deals to market, issued over $62 billion in notes, and transferred a portion of the credit risk to private investors on over $2 trillion in single-family mortgage loans, measured at the time of the transaction. The reference pool for CAS Series 2023-R05 consists of approximately 64,000 single-family mortgage loans with an outstanding unpaid principal balance of approximately $20.2 billion. The loans included in this transaction are fixed-rate, generally 30-year term, fully amortizing mortgages and were underwritten using rigorous credit standards and enhanced risk controls.

Freddie Mac released its 2022 Green MBS Impact Report showing the company issued $1.372 billion of Single-Family Green Mortgage-Backed Securities (MBS) for the year. The report provides an overview of Freddie Mac’s Sustainability Strategy and Single-Family Green Bond Framework and highlights the estimated impact of the enterprise’s Single-Family Green MBS program. The size of Freddie’s Green MBS issuance doubled from 2021 to 2022, reflecting market demand and the expansion of eligible collateral to include loans backed by homes with a qualifying Home Energy Rating System (HERS) score. From its inception in 2021 to year end 2022 Freddie Mac Single-Family Green MBS Issuance totaled nearly $2 billion unpaid principal balance of bonds. The bonds were backed by more than 6,400 Freddie Mac mortgages secured by newly constructed homes with a qualifying HERS rating, or GreenCHOICE Mortgages where the proceeds or portion thereof from each refinanced mortgage paid off existing debt that was used to finance the purchase and installation of solar panels. Freddie Mac estimates that the collateral in its 2022 Single-Family Green MBS issuance saved enough energy to power more than 2,000 homes for a year, avoided greenhouse gas emissions the equivalent of taking nearly 3,800 cars off the road for a year, and saved an estimated average of $722 in annual utility costs for each homeowner with a mortgage included in a 2022 Freddie Mac Single-Family Green MBS.

We’re entering the college football bowl season, so how about some gridiron humor? (Suitable for changing to any school – don’t send me “you insulted my daddy’s alma matter” e-mails please.)
If three Florida State football players are in the same car, who is driving? The police officer.
How can you tell if an Auburn football player has a girlfriend? There’s tobacco juice on both sides of the pickup truck.
What do you get when you put 32 Arkansas cheerleaders in one room? A full set of teeth.
University of Michigan Coach Brady Hoke is only going to dress half of his players for the game this week; the other half will have to dress themselves.

 

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Rob Chrisman