Housing Finance: Transition and Uncertainty Continues

Market faith now at a premium

by Ron D’Vari, CEO,  James Frischling, President, Richard Kelly, Managing Director, and Asim Ali, Director, NewOak.

Since the credit crisis, U.S. housing finance has been subject to significant change, disruption and dysfunction. The saga seems to continue as the housing finance landscape is expected to evolve further, while market faith in it remains uncertain.

Myriads of conflicting policies and regulatory factors have contributed to the atmosphere of uncertainty in the market, including: 1) tighter mortgage underwriting rules imposed by qualified mortgage/qualified residential mortgage (QM/QRM) rules; 2) evolving, ambiguous and challenging securitization rules; 3) stricter fair lending and servicing regulations; and 4) the doubtful future surrounding government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac despite their current dominance of more than 85% of the mortgage market. These factors have combined to create anemic private-label mortgage issuance and a sputtering housing market. Healthier housing finance will be a significant driver of U.S. economic growth and will be closely monitored by the whole market.

The game has changed not just because of new rules but also because of the more vigorous attention various government agencies and regulators are paying to existing rules. Enforcement in servicing and fair lending are among top priorities of government agencies at both federal and state levels. For example, the New York Department of Financial Services has stated concerns about non-bank servicers’ capacity to properly handle significant portfolio growth coming from bank servicing transfers and has put on hold a transfer of $39 billion in mortgage servicing rights (MSR) from Wells Fargo to Ocwen. Also the U.S. Department of Justice has been intensifying its collaboration with other federal agencies and bank regulators and has settled 12 fair lending cases and secured over $600 million in settlements since October 2011.

In addition, mortgage-related investigations stemming from the financial crisis are continuing. According to Michael P. Stephens, acting inspector general of the Federal Housing Finance Authority (FHFA), a working group of federal and state authorities focused on legacy mortgage litigations, there are still “more than a dozen ongoing investigations,” which will lead to billions of dollars in additional costs to financial companies”.

In response, banks are adjusting their pricing for originating and servicing loans and are expecting mortgage activity to be a big source of income very soon. Obtaining a mortgage may soon get easier as FHFA chief Mel Watt has stated GSEs will make credit more readily available to homeowners. However, this will further delay the private market solution everyone is hoping to achieve. So the mortgage market transition continues.

Residential Mortgage Market: Still Sick?

“The mortgage market is sick,” said David Stevens, the assistant secretary for housing and federal housing commissioner at the U.S. Department of Housing and Urban Development (HUD), at the Mortgage Bankers Association (MBA) national conference. That was four years ago.

Last week, now president and CEO of the MBA, Stevens opened the 2014 conference by saying that the market was “still sick”. Government-sponsored enterprises continue to account for about 90% of the mortgage market, and the overarching question at this industry event is when will the private-label residential mortgage market make a comeback?

The regulatory environment generally and the Dodd-Frank Act specifically are often blamed for the lack of non-agency mortgages, along with tighter credit standards and the risk of mortgage litigation. Yet the general thought expressed by key executives at the MBA conference was not enough had changed to convince investors that it’s safe to put more than a toe in the water.

...here are still "more than a dozen ongoing investigations," which will lead to billions of dollars in additional costs to financial companies

According to the MBA’s Stevens, “transparency, trust and confidence in data” are the keys to bringing private capital back. Kenneth Donohue, the former inspector general for HUD, talked about “truth, honesty and respect,” noting that without a commitment to those beliefs “we won’t have customers.” Bill O’Reilly, one of the featured speakers, concluded his talk by telling the audience to “be honest, think about your country, at least a little bit, and live up to your potential.”

Residential mortgages and the securitization process is a fairly quantitative and complex business, yet the speakers mentioned as well as others spoke far less about the math and much more about the integrity of the business and the manner in which the people in it should conduct themselves.

There are plenty of excuses to go around in rationalizing what went wrong. The challenge now is to rebuild trust and confidence in the market and its players. If we don’t, in four years the MBA’s national event will again open with someone saying the residential mortgage market is “still sick” and that’s a refrain no one wants to hear.

Regulation AB II: What Price Transparency?

Investors and regulators are demanding more transparency and disclosure of specific loan-level information for asset-backed securities (ABS) than issuers are used to. And that additional transparency will likely come at a cost, along with additional privacy and liability concerns.

The second comment period for the Securities and Exchange Commission’s (SEC) re-proposed Regulation AB II closed on March 28, and the SEC is presumably digesting the enormous number of comments it has received from various securities industry participants.

A key goal of Reg. AB II is to provide greater transparency in ABS loan-level collateral. A worthy goal to be sure, though it turns out to be tricky to reconcile the competing goals of transparency on the one hand and privacy on the other. Public dissemination of borrower data (including information that can be identified with a specific individual) violates both the spirit and letter of the privacy protections contained in the Gramm-Leach-Blyley Act and the Fair Credit Reporting Act.

The SEC’s original proposal (to simply post loan-level data on EDGAR for all the world to see) created a storm of protest and was withdrawn. The SEC has requested comments on other ways to solve the dilemma. The problem is most acute in the mortgage-backed securities (MBS) area (as opposed to, say, securitized auto loans), where the requested data is much more extensive and detailed. There seems to be agreement that in the MBS arena there is no way to “fuzz” the data to prevent reverse engineering it to identify individual borrowers (thereby violating existing laws regarding privacy and data handling). The only practical solution to privacy concerns seems to be finding a way to limit access to sensitive data (to QIPs, for example).

Naturally, industry participants have different interests and concerns. Issuers do not like the compliance expense, and are concerned about both privacy liability and securities law liability (for material omissions or misstatements in the loan data presented). The investor community wants the more detailed information, but they are concerned with the expense (once they have the data, they may be obliged to actually do something with it – like review and evaluate it), and with the privacy issues. In addition, issuers may be unwilling to make extensive representations and warranties when they have delivered loan-level data to investors.

Clearly some form of required disclosure of loan-level data is required and is coming. What form it takes, and whether the additional transparency will be worth the cost, remains to be seen.




About NewOak
NewOak is an independent financial services advisory firm built for today’s global markets. Led by a team of experienced market and legal practitioners, NewOak provides a broad range of services across multiple asset classes, complex securities and structured products for banks, insurers, asset managers, law firms and regulators, including financial advisory and dispute resolution, valuation, credit and compliance, risk management, stress testing, model validation and financial technology solutions. We have analyzed or advised on more than $4.5 trillion in assets to date. Visit www.newoak.com