Tag Archives: Alt-A

Subprime v. Non-Prime

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The Kroll Bond Rating Agency has issued an RMBS Research report, Credit Evolution: Non-Prime Isn’t Yesterday’s Subprime. It opens,

Following the private label RMBS market’s peak in 2007 and the ensuing credit crisis, non-agency securitizations of newly originated collateral have focused almost exclusively on prime jumbo loans. This is not surprising given the poor performance of loosely underwritten residential mortgage loans that characterized certain vintages leading up to the crisis. While legacy prime, in absolute terms, performed better than Alt-A and subprime collateral, it was apparent that origination practices had a significant impact on subsequent loan performance across product types.

Many consumers were caught in the ensuing waves of defaults, which marred their borrowing records in a manner that has either barred them from accessing housing credit, or at best made it extremely challenging to obtain a home loan. Others that managed to meet their obligations have been unable to qualify for new loans in the post-crisis era due to tighter credit standards that have been influenced by regulation.

The private label securitization market has not met the needs of these consumers for a number of reasons, including, but not limited to, reputational concerns in the aftermath of the crisis, regulatory costs, investor appetite, and the time needed for borrowers to repair their credit. The tide appears to be turning quickly, however, and Kroll Bond Rating Agency (KBRA) has observed the re-emergence of more than a dozen non-prime mortgage origination programs that intend to use securitization as a funding source. Of these, KBRA is aware of at least four securitization sponsors that have accessed the PLS market across nine issuances, two of which include rated offerings.

Thus far, KBRA has observed that today’s non-prime programs are not a simple rebranding of pre-crisis subprime origination, nor do they signal a return to the documentation excesses associated with “liar loans”. While the asset class is meant to serve those with less pristine credit, and can even have characteristics reminiscent of legacy Alt-A, it is expansive, and underwriting practices have been heavily influenced by today’s consumer-focused regulatory environment and government-sponsored entity (GSE) origination guidelines. In evaluating these new non-prime programs, KBRA believes market participants should consider the following factors:

■ Loans originated under sound compliance with Ability-To-Repay (ATR) rules should outperform 2005-2007 vintage loans with similar credit parameters, including LTV and borrower FICO scores. The ATR rules have resulted in strengthened underwriting, which should bode well for originations across the MBS space. This is particularly true of non-prime loans, where differences in origination practices can have a greater influence on future loan performance.

■ Loans that fail to adhere to GSE guidelines regarding the seasoning of credit dispositions (e.g. bankruptcy, foreclosure, etc.) on a borrower’s credit history should be viewed as having increased credit risk relative to those with similar credit profiles that lack recent disposition activity. This relationship likely depends on, among other things, equity position, current FICO score, and the likelihood that any life events relating to the prior credit issue remain unresolved.

■ Alternative documentation programs need to viewed with skepticism as they relate to the ATR rules, particularly those that serve borrowers with sub-prime credit histories. Although many programs will meet technical requirements for income verification, it is also important to demonstrate good faith in determining a borrower’s ability-to-repay. Failure to do so may not only result in poor credit performance, but increased risk of assignee liability.

■ Investor programs underwritten with reliance on expected rental income and limited documentation may pose more risk relative to fully documented investor loans where the borrower’s income and debt profile are considered, all else equal. (1, footnotes omitted)

I think KBRS is documenting a positive trend: looser credit for those with less-than-prime credit is overdue. I also think that KBRS’ concerns about the development of the non-prime market should be heeded — ensuring that borrowers have the ability to repay their mortgages should be job No. 1 for originators (although it seems ridiculous that one would have to say that). We want a mortgage market that serves everyone who is capable of making their mortgage payments for the long term. These developments in the non-prime market are most welcome and a bit overdue.

Mortgage Market Overview

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The Urban Institute’s Housing Finance Policy Center issued its May 2016 Housing Finance at a Glance Chartbook. This monthly report is invaluable for those of us who follow the mortgage market closely. The mortgage market changes so quickly and so much that what one thinks is the case is often no longer the case a few months later. This month’s report has new features, including Housing Credit Availability Index and first-time homebuyer share charts. Here are some of the key findings of the May report:

  • The Federal Reserve’s Flow of Funds report has consistently indicated an increasing total value of the housing market driven by growing household equity in each quarter of the past 2 years, and the trend continued according to the latest data, covering Q4 2015. Total debt and mortgages increased slightly to $9.99 trillion, while household equity increased to $13.19 trillion, bringing the total value of the housing market to $23.18 trillion. Agency MBS make up 58.2 percent of the total mortgage market, private-label securities make up 6.1 percent, and unsecuritized first liens at the GSEs, commercial banks, savings institutions, and credit unions make up 29.4 percent. Second liens comprise the remaining 6.4 percent of the total. (6)

It is worth wrapping your head around the size of this market. Total American wealth is about $88 trillion, so household equity of $13 trillion is about 15 percent of the total. With debt and mortgages at $10 trillion, the aggregate debt-to-equity ratio is nearly 45%.

  • As of March 2016, debt in the private-label securitization market totaled $613 billion and was split among prime (19.5 percent), Alt-A (42.2 percent), and subprime (38.3 percent) loans. (7)

This private-label securitization total is a pale shadow of the height of the market in 2007, back to the levels seen in 1999-2000. It is unclear when and how this market will recover — and the extent to which it should recover, given its past excesses

  • First lien originations in 2015 totaled approximately $1,735 billion. The share of portfolio originations was 30 percent, while the GSE share dropped to 46 percent from 47 in 2014, reflecting a small loss of market share to FHA due to the FHA premium cut. FHA/VA originations account for another 23 percent, and the private label originations account for 0.7 percent. (8)

The federal government, through Fannie Mae, Freddie Mac and Ginnie Mae, is insuring 69 percent of originations. Hard for me to think this is good for the mortgage market in the long term. There is no reason that the private sector could not take on a bigger share of the market in a responsible way.

  • Adjustable-rate mortgages (ARMs) accounted for as much as 27 percent of all new originations during the peak of the recent housing bubble in 2004 (top chart). They fell to a historic low of 1 percent in 2009, and then slowly grew to a high of 7.2 percent in May 2014. (9)

It is pretty extraordinary to see the extent to which ARMs change in popularity over time, although it makes a lot of sense. When interest rates are high and prices are high, more people prefer ARMs and when they are low they prefer FRMs.

  • Access to credit has become extremely tight, especially for borrowers with low FICO scores. The mean and median FICO scores on new originations have both drifted up about 40 and 42 points over the last decade. The 10th percentile of FICO scores, which represents the lower bound of creditworthiness needed to qualify for a mortgage, stood at 666 as of February 2016. Prior to the housing crisis, this threshold held steady in the low 600s. LTV levels at origination remain relatively high, averaging 85, which reflects the large number of FHA purchase originations. (14)

It is hard to pinpoint the right level of credit availability, particularly with reports of 1% down payment mortgage programs making the news recently. But it does seem like credit can be loosened some more without veering into bubble territory.

Hard to keep up with all of the changes in the mortgage market, but this chartbook sure does help.

Visualizing The Residential Mortgage Market

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Compass Point Research & Trading, LLC has a nice graph, The Mortgage Market Overview, that helps to make sense of the massive U.S. residential mortgage market. It breaks down the $20 trillion dollar U.S. residential housing market into debt and equity and then further breaks down debt into the various available types, by market share: GSE; portfolio; private-label MBS; etc.  A picture can be worth twenty trillion words . . ..

Reiss in Bloomberg on CS Lawsuit

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Bloomberg quoted me in Credit Suisse Waits for $11 Billion Answer in N.Y. Fraud Suit.  It reads in part,

As Credit Suisse Group AG (CSGN) sees it, time has run out on New York Attorney General Eric Schneiderman’s pursuit of Wall Street banks for mortgage fraud that helped trigger the financial crisis.

Schneiderman sued Credit Suisse in 2012 as part of a wide-ranging probe into mortgage bonds. He claimed Switzerland’s second-largest bank misrepresented the risks associated with $93.8 billion in mortgage-backed securities issued in 2006 and 2007.

Credit Suisse asked a Manhattan judge in December to dismiss Schneiderman’s case, as well as his demand for as much as $11.2 billion in damages. The bank argued that New York, by waiting so long to file the lawsuit, missed a three-year legal deadline for suing. The state countered that it had six years to file its complaint.

If the bank wins, Schneiderman will face a new roadblock as he considers similar multibillion-dollar claims against a dozen other Wall Street firms. The judge in New York State Supreme Court could rule at any time.

“It would obviously tilt everything in the favor of Credit Suisse and similarly situated financial institutions,” said David Reiss, a professor at Brooklyn Law School, hindering New York’s remaining efforts to hold banks accountable for mistakes that spurred a recession.

*     *     *

Since the latest bonds cited in Schneiderman’s suit originated in 2006 and 2007, if the judge chooses the bank’s argument, the lawsuit may be dismissed. If the judge takes Schneiderman’s more expansive view, most or all of the suspect bonds may still be covered by the litigation.

“The entire case is time-barred,” Richard Clary, a lawyer for the bank, told Friedman at the December hearing. Lawyers for the state argued that such limits weren’t intended to apply to the attorney general.

“We’ve successfully resolved cases filed within six years,” Deputy Attorney General Virginia Chavez Romano said, citing last year’s JPMorgan accord. “It has been our decades-long practice.”

So far, New York’s courts have broadly interpreted the statute in finding a six-year period, Brooklyn Law School’s Reiss said. That may be changing as legal scholars and financial industry lawyers question its propriety.

“Having these incredibly long and ambiguous statutes of limitations is not particularly fair,” he said.

*     *     *

Friedman’s ruling in the Credit Suisse case may be crucial to Schneiderman’s probe of close to a dozen other banks, and whether he can sue them successfully.

New York agreed with the firms in October 2012 that any legal deadline for bringing fraud claims against them would be suspended while he continues his investigation, a person familiar with the matter said.

Such tolling agreements stopped the clock on any statute of limitations and ensured Schneiderman can bring fraud claims against banks for conduct going as far back as 2006, said the person.

Brooklyn Law School’s Reiss said the banks may have agreed to the delay to avoid forcing Schneiderman to file a “kitchen sink complaint with every possible allegation in it” just to beat the clock. Doing so also builds good will with regulators and may also facilitate a favorable settlement.

The agreements don’t necessarily mean that suits will be filed, the person said. If Schneiderman sues any of the banks, they may then assert the statute of limitations is three years, and not six, just as Credit Suisse has done.

*     *     *

This may be a more potent argument if Friedman rules for the Swiss bank in the pending case.

A three-year statute-of-limitations would mean they can’t be held responsible for transactions before 2009, while a six-year deadline would allow Schneiderman to reach back to 2006.

There’s “great uncertainty” about whether Schneiderman can move forward with the Credit Suisse case in light of the statute of limitations arguments, said James Cox, a corporate law professor at Duke University in Durham, North Carolina.

Reiss said that any ruling would probably be challenged all the way to the Court of Appeals in Albany, the state’s highest court.

Federalizing Monoline Mortgage Insurance

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The Federal Insurance Office of the Department of Treasury issued a report required pursuant to Dodd-Frank, How To Modernize And Improve The System Of Insurance Regulation In The United States, which addresses among other things the state of the monoline mortgage insurance industry:

Recommendation: Federal standards and oversight for mortgage insurers should be developed and implemented.

Like financial guarantors, private mortgage insurers are monoline companies that experienced devastating losses during the financial crisis. A business predominantly focused on providing credit enhancement to mortgages guaranteed by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, mortgage insurers migrated from the core business of insuring conventional, well-underwritten mortgage loans to providing insurance on pools of Alt-A and subprime mortgages in the years leading up to the financial crisis. The dramatic decline in housing prices and the impact of the change in underwriting practices required mortgage insurers to draw down capital and reserves to pay claims resulting in the failure of three out of the eight mortgage insurers in the United States. Historically high levels of claim denials, including policy rescissions, helped put taxpayers at risk.

Regulatory oversight of mortgage insurance varies state by state. Though mortgage insurance coverage is provided nationally, only 16 states impose specific requirements on private mortgage insurers. Of these requirements, two govern the solvency regime and, therefore, are of particular significance: (1) a limit on total liability, net of reinsurance, for all policies of 25 times the sum of capital, surplus, and contingency reserves, (known as a 25:1 risk-to-capital ratio); and (2) a requirement of annual contributions to a contingency reserve equal to 50 percent of the mortgage insurer’s earned premium. In addition to the states, the GSEs (and through conservatorship, the Federal Housing Finance Agency) establish uniform standards and eligibility requirements that in some cases are more stringent than those required by state regulators. As the financial crisis unfolded, mortgage insurers no longer met state or contractual capital requirements. State regulators granted waivers in order to allow mortgage insurers to continue to write new business while the GSEs loosened other standards that were applicable to mortgage insurers.

The private mortgage insurance sector is interconnected with other aspects of the federal housing finance system and, therefore, is an issue of significant national interest. As the United States continues to recover from the financial crisis and works to reform aspects of the housing finance system, private mortgage insurance may be an important component of any reform package as an alternative way to place private capital in front of any government or taxpayer risk. Robust national solvency and business practice standards, with uniform implementation, for mortgage insurers would help foster greater confidence in the solvency and performance of housing finance. To achieve this objective, it is necessary to establish federal oversight of federally developed standards applicable to mortgage insurance. (31-32)

This critique of the monoline insurance industry seems accurate to me. The industry has a tendency to fail when it is needed most — during major financial crises. Having multiple states regulate monoline insurers allows this nationally (and globally) significant industry to engage in regulatory arbitrage — that is, finding the most pliable regulatory environment in which to operate. National regulation would solve that problem. As always, a single federal regulator is more prone to capture by the industry it regulates than a bunch of state regulators. We have, however, tried the alternative and it has not worked so well. I think a federal approach is worth a try.

A HELOC of a Securitization

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S&P posted A Look At U.S. Second-Lien And HELOC Transactions Post-Crisis.  In 2008, they announced that “would halt rating new U.S. RMBS closed-end second-lien transactions because loan performance had deteriorated significantly.  [They] haven’t rated any U.S. RMBS second-lien (both second-lien HCLTV [high-combined loan-to-value] and closed-end second-lien) or HELOC [home equity line of credit] transactions since 2007.” (1) They also note that notwithstanding the fact that such securitizations had ended, “HELOC loans continue to be originated, with banks generally keeping these types of loans on their books.” (1)

The report provides a some interesting data on those securitizations.  Let me share one highlight, a table of lifetime loss projections of RMBS with different collateral types. For the 2007/2008 vintage, they performed as follows.

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Second-lien  HCLTV:  45%

Closed-end second lien:  58%

HELOC:  42%

Subprime:  49%

Alt-A:  29.25%

Negative Amortization:  43.25%

Prime:  10%

With a bit of understatement, they conclude that “[c]losed-end second-lien transactions may be limited going forward because of limited investor and issuer appetite, given past performance and uneven home price appreciation.” (5) They note that HELOCs are not included in the definition of Qualified Mortgages or Qualified Residential Mortgages [QRM] “so the issuer would most likely have to retain a stake in the deal, increasing issuance costs.” (6)

This seems like a good a good result, if you ask me. Here is a product that performed miserably (with losses of greater than 40%!!!) as a securitization. If the new QRM rules reduce these securitization but banks continue to originate them for their own portfolio, perhaps Dodd-Frank is doing its job in the mortgage markets. Of course, we want to ensure that there is sufficient sustainable credit for HELOCs, but it is good to see that portfolio lenders are stepping in where they see a market that RMBS issuers has exited.