Tag Archives: mortgage

FHA Annual Check-up

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The Department of Housing and Urban Development released its Annual Report to Congress Regarding the Financial Status of the FHA Mutual Mortgage Insurance Fund. The MMIF fund is the FHA’s main vehicle for insuring mortgages. As we saw last week, FHA reverse mortgage (formally known as “Home Equity Conversion Mortgage” or “HECM”) portfolio is not doing so well. FHA standard (sometimes referred to as “forward”) mortgages are doing better, although their performance is also slipping.

The MMIF declined from its 2.35 percent FY 2016 Capital Ratio to 2.09 percent. This still exceeds its statutorily-required level of 2.00 percent.  The Economic Net Worth of the MMIF was $25.6 billion while the MMIF Insurance-in-Force was approximately $1.23 trillion at the end of FY 2017. The decline was driven by the negative Economic Net Worth of the reverse mortgage portfolio, as the capital ratio for the forward mortgage portfolio on its own was 3.33%.

The report contains a multitude of useful tables and charts about the FHA’s mortgage portfolio. The FHA has an 18 percent share of the mortgage market, which is pretty high. (Table A-2) Indeed, it is in the same range of its market share during the financial crisis years (2008-2010). The FHA remains a strong force in the first-time homebuyer market, with an 82.2 percent share. (Table B-2)

The FHA’s objectives for FY 2018 are worth reviewing:

Play a Significant Role in Disaster Recovery. In the wake of Hurricanes Irma, Harvey, and Maria, and wildfires in California, in FY 2017 and the first part of FY 2018, FHA has played a significant role in relief and recovery efforts in affected areas, while taking immediate actions to protect its Single Family assets and financial exposure. (78)

Make Necessary Changes to the Home Equity Conversion Program (HECM). During FY 2017, FHA revised the HECM initial and annual Mortgage Insurance Premiums (MIPs), and Principal Limit Factors (PLFs). These revisions were necessary to enable FHA to continue to endorse HECM loans in FY 2018, protect the program for seniors, and balance serving FHA’s mission with taxpayer protection. (79)

No less important than these objectives is the FHA’s second-to-last one, Technology Modernization:

FHA is working to update its systems over the coming years to allow the Agency to work more effectively with lenders participating in the program, while operating FHA with greater efficiency and control. The technology systems that support FHA’s Single Family business have an average age of more than 18 years, with the Computerized Homes Underwriting Management System (CHUMS) exceeding 40 years. Similarly, the systems supporting the servicing, default, claims and REO areas have an average age of 14 years. FHA’s systems have been maintained, modified and enhanced over the years, but it has become fundamentally difficult and exceedingly expensive to maintain systems beyond their usable life. FHA’s outdated systems make it more difficult to work with lenders and to collect and manage important data. FHA remains a largely paper-processing entity while the rest of the industry has increasingly migrated to digital processes. FHA needs systems that can capture and effectively process the extensive volumes of data now in use, with enhanced storage and processing capabilities to handle the migration from paper forms to digital ones. Additionally, FHA requires the ability to analyze and manage insured loans comprehensively over the many phases of the mortgage life cycle. (80)

When you stop and think about how bad the state of the FHA’s technology is, you think that maybe this should be their top priority.

A Shortage of Short Sales

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Calvin Zhang of the Federal Reserve Bank of Philadelphia has posted A Shortage of Short Sales: Explaining the Under-Utilization of a Foreclosure Alternative to SSRN. The abstract reads,

The Great Recession led to widespread mortgage defaults, with borrowers resorting to both foreclosures and short sales to resolve their defaults. I first quantify the economic impact of foreclosures relative to short sales by comparing the home price implications of both. After accounting for omitted variable bias, I find that homes selling as a short sale transact at 8.5% higher prices on average than those that sell after foreclosure. Short sales also exert smaller negative externalities than foreclosures, with one short sale decreasing nearby property values by one percentage point less than a foreclosure. So why weren’t short sales more prevalent? These home-price benefits did not increase the prevalence of short sales because free rents during foreclosures caused more borrowers to select foreclosures, even though higher advances led servicers to prefer more short sales. In states with longer foreclosure timelines, the benefits from foreclosures increased for borrowers, so short sales were less utilized. I find that one standard deviation increase in the average length of the foreclosure process decreased the short sale share by 0.35-0.45 standard deviation. My results suggest that policies that increase the relative attractiveness of short sales could help stabilize distressed housing markets.

The paper highlights the importance of aligning incentives in the mortgage market among lenders, investors, servicers and borrowers. Zhang makes this clear in his conclusion:

While these individual results seem small in magnitude, the total economic impact is big because of how large the real estate market is. A back-of-the-envelope calculation suggests that having 5% more short sales than foreclosures would have saved up to $5.8 billion in housing wealth between 2007 and 2011. Thus, there needs to be more incentives for short sales to be done. The government and GSEs already began encouraging short sales by offering programs like HAFA [Home Affordable Foreclosure Alternatives] starting in 2009 to increase the benefits of short sales for both the borrower and the servicer, but more could be done such as decreasing foreclosure timelines. If we can continue to increase the incentives to do short sales so that they become more popular than foreclosures, future housing downturns may not be as extreme or last as long. (29)

Manafort Indicted for Real Estate Fraud

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Special Counsel Mueller

Paul Manafort and his protege, Richard Gates III, were indicted on a variety of charges, including conspiracy, failure to file requirement financial reports and the making of false statements. The indictment was signed by Special Counsel Mueller. A number of the allegations involve real estate transactions. Here are the highlights (lowlights?) of the allegations that document how money can be laundered through real estate:

Manafort used his hidden overseas wealth to enjoy a lavish lifestyle in the United States, without paying taxes on that income.  Manafort, without reporting the income to his tax preparer or the United States, spent millions of dollars on luxury goods and services for himself and his extended family through payments wired from offshore nominee accounts to  United States vendors.  Manafort also used these offshore accounts to purchase multi-million dollar properties in the United Sates.  Manafort then borrower millions of dollars in loans using these properties as collateral, thereby obtaining cash in the United States without reporting and paying taxes on the income.  In order to increase the amount of money he could access in the United States, Manafort defrauded the institutions that loaned money on these properties so that they would lend him more money at more favorable rates than he would otherwise be able to obtain. (para 4)

More than $75,000,000 flowed through Manafort and Gate’s 15 offshore accounts. They also had 17 US corporations through which some of these funds flowed as well. In order to avoid paying taxes on this money, Manafort and Gates made millions of dollars in wire transfers to pay “for goods, services and real estate.” (para. 15) Manafort spent more than $12,000,000 on personal items including home improvement services, clothing, cars and housekeeping. He also bought four properties for over $6,000,000.

After Manafort bought these properties, “he took out mortgages on the properties thereby allowing Manafort to have the benefits of liquid income without paying taxes on it. Further, Manafort defrauded the banks that loaned him the money so that he could withdraw more money at a cheaper rate than he otherwise would have been permitted.” (para. 33) He did this by wrongfully claiming on a loan application that an investment property was owner-occupied (banks generally give you a more favorable interest rate if the property is owner-occupied). He was also able to borrow more money by claiming that part of the proceeds of a loan would be used to fund a renovation when in fact he did not intend to use the funds for that purpose.

The allegations in the indictment provide a nice case study of how real estate is used in money laundering.

Mortgage Servicing Since The Financial Crisis

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photo by Dan Brown

Standard & Poors issued a report, A Decade After The Financial Crisis, What’s The New Normal For Residential Mortgage Servicing? It provides a good overview of how this hidden infrastructure of the mortgage market is functioning after it emerged from the crucible of the subprime and foreclosure crises. It reads, in part,

Ten years after the start of the financial crisis, residential mortgage servicing is finally settling into a new sense of normal. Before the crisis, mortgage servicing was a fairly static business. Traditional prime servicers had low delinquency rates, regulatory requirements rarely changed, and servicing systems were focused on core functions such as payment processing, investor accounting, escrow management, and customer service. Subprime was a specific market with specialty servicers, which used high-touch collection practices rather than the low-touch model prime servicers used. Workout options for delinquent borrowers mainly included repayment plans or extensions. And though servicers completed some modifications, short sales, and deeds in lieu of foreclosure, these were exceptions to the normal course of business.

Today, residential mortgage servicing involves complex regulation, increased mandatory workout options, and multiple layers of internal control functions. Over the past 10 years servicers have had to not only modify their processes, but also hire more employees and enhance their technology infrastructure and internal controls to support those new processes. As a result, servicing mortgage loans has become less profitable, which has caused loan servicers to consolidate and has created a barrier to entry for new servicers. While the industry expects reduced regulatory requirements under the Trump administration and delinquency rates to continue to fall, we do not foresee servicers reverting to pre-crisis operational processes. Instead, we expect states to maintain, and in some cases enhance, their regulatory requirements to fill the gap for any lifted or reduced at the federal level. Additionally, most mortgage loan servicers have already invested in new processes and technology, and despite the cost to support these and adapt to any additional requirements, we do not expect them to strip back the controls that have become their new normal. (2/10, citation omitted)

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As The Economy Improves, Delinquency Rates Have Become More Stable

Total delinquency rates have only just begun returning to around pre-crisis levels as the economy–and borrowers’ abilities to make their mortgage payments–has improved (see charts 1 and 2). Lower delinquency rates can also be attributed to delinquent accounts moving through the default management process, either becoming reperforming loans after modifications or through liquidation. New regulatory requirements have also extended workout timelines for delinquent accounts. In 2010, one year after 90-plus delinquency rates hit a high point, the percentage of prime and subprime loans in foreclosure actually surpassed the percentage that were more than 90 days delinquent–a trend that continued until 2013 for prime loans and 2014 for subprime loans. But since the end of 2014, all delinquency buckets have remained fairly stable, with overall delinquency rates for prime loans down to slightly over 4% for 2016 from a peak of just over 8% in 2009. Overall delinquency rates for subprime loans have fluctuated more since the peak at 29% in 2009. (2/10)

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Modifications Now Make Up About Half Of Loan Workout Strategies

Government agencies and government-sponsored enterprises (Fannie Mae and Freddie Mac) developed new formal modification programs beginning in 2008 to address the rising delinquency and foreclosure rates. The largest of these programs was HAMP, launched in March 2009. While HAMP was required for banks accepting funds from the Troubled Asset Relief Program (TARP), all servicers were allowed to participate. These programs required that servicers exhaust all loss mitigation options before completing foreclosure. This requirement, and the fact that servicers started receiving incentives to complete modifications, spurred the increase in modifications. (4/10)

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Foreclosure Timelines Have Become Longer

As the number of loans in foreclosure rose during the financial crisis, the requirements associated with the foreclosure process grew. As a result, the time it took to complete the foreclosure process increased to almost 475 days in 2016 from more than 160 days in 2007–an increase of almost 200%. While this is not a weighted average and therefore not adjusted for states with smaller or larger foreclosure portfolios, which could skew the average, the data show longer timelines across all states. And even though the percentage of loans in foreclosure has decreased in recent years (to 1% and 9% by the end of 2016 for prime and subprime, respectively, from peaks of 3% in 2010 and 13% in 2011) the time it takes to complete a foreclosure has still not lessened (6/10)

Improving the 30-Year Mortgage

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Wayne Passmore and Alexander von Hafften have posted Improving the 30-Year Fixed-Rate Mortgage to SSRN. The abstract reads,

The 30-year fixed-rate fully amortizing mortgage (or “traditional fixed-rate mortgage”) was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Third, refinancing mortgages is often very costly. We propose a new fixed-rate mortgage, called the Fixed-Payment-COFI mortgage (or “Fixed-COFI mortgage”), that resolves these three flaws. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders. Fixed-COFI mortgages may help some renters gain access to homeownership. These renters may be, for example, paying rents as high as comparable mortgage payments in high-cost metropolitan areas but do not have enough savings for a down payment. The Fixed-COFI mortgage may help such renters, among others, purchase homes.

The authors acknowledge some drawbacks for Fixed-COFI mortgages that can make them unattractive to some borrowers:

What do homeowners lose by choosing Fixed-COFI mortgages instead of traditional fixed-rate mortgages? First, they cannot freely spend refinancing gains on non-housing items. When mortgage rates fall, homeowners with Fixed-COFI mortgages automatically pay less interest and pay down the mortgage principal more. Second, they can no longer “win the lottery” played with capital markets investors and lock in a substantially lower rate for the remainder of their mortgage. With Fixed-COFI mortgages, homeowners trade the option of prepayment for faster home equity accumulation. We believe that many households may prefer Fixed-COFI mortgages to traditional fixed-rate mortgages. Furthermore, we believe that many renting households without savings for a down payment may prefer Fixed-COFI mortgages to renting. (4)

American households rely too much on the plain vanilla 30-year fixed rate mortgage for their own good. Papers like this give us some reasonable alternatives that might be better suited for many households.

The Next Taxpayer Bailout for the Mortgage Market?

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The HUD Office of the Inspector General issued an audit on Nonbank Oversight by Ginnie Mae. This audit is one of those dry government documents that contain whispers of crises to come. The worrisome sentence is buried at the end of the audit: “If disruption in servicing occurs, Ginnie Mae may need to request additional funds from the U.S. Treasury to pay investors.” (8) To understand what is at stake, it is worth reviewing the background of the audit:

The Housing and Urban Development Act of 1968 created the Government National Mortgage Association (Ginnie Mae), a wholly owned U.S. Government corporation within the U.S. Department of Housing and Urban Development, to pursue the creation of a mortgage-backed security market for government-insured loans. Through its mortgage-backed securities programs, Ginnie Mae guarantees securities backed by pools of mortgages and issued by mortgage lenders approved by Ginnie Mae. Ginnie Mae refers to these mortgage lenders as Ginnie Mae issuers.

Ginnie Mae depends on its issuers to take full responsibility for servicing, remitting, and reporting activities for the mortgages in every pool. If the borrower fails to make a timely payment on its mortgage, the issuer must use its own funds to ensure that the investors receive timely payment. If an issuer cannot ensure the timely payment of principal and interest to investors, Ginnie Mae, in accordance with its guaranty, defaults the issuer, acquires the servicing of the loans, and uses its own funds to manage the portfolio and make any necessary advances to investors. Ginnie Mae’s risk for loss occurs almost entirely at the point of issuer default, when Ginnie Mae must step in and exercise its guaranty. Counterparty risk refers to the risk of issuer default.

Following the financial crisis, the demand for government-insured loans increased, which created an increased demand for Ginnie Mae’s product. Ginnie Mae’s total remaining principal outstanding increased from $427.6 billion in 2007 to $1.7 trillion in 2016. This represents a 300 percent increase. The chart below shows the growth of the outstanding remaining principal balance of Ginnie Mae’s mortgage-backed securities programs from 2007 to 2016.

In addition to an increase in demand for Ginnie Mae’s products, Ginnie Mae’s issuer base had shifted dramatically since the financial crisis. Banks retreated from mortgage lending, causing a shift in Ginnie Mae’s issuer base from banks to nonbanks. For the purpose of this report, a bank refers to an institution licensed to receive deposits and make loans, whereas a nonbank refers to institutions that offer only mortgage-related services. In 2014, Ginnie Mae reported that 6 of its top 10 issuers were nonbanks. The chart below illustrates the shift in Ginnie Mae’s issuer base since 2010.

When banks dominated Ginnie Mae’s issuer base, Ginnie Mae outsourced a significant portion of its risk management to bank regulators, such as the Federal Deposit Insurance Corporation, the Federal Reserve, the Office of the Comptroller of the Currency, and the National Credit Union Association. While the Consumer Financial Protections Bureau regulates nonbanks for consumerrelated issues, nonbanks are not subject to the same safety and soundness regulation as banks. No equivalent regulator exists for nonbanks. Therefore, Ginnie Mae must function as the first line of defense to evaluate nonbank institutions for financial and operational soundness. Ginnie Mae’s Office of Issuer and Portfolio Management is responsible for overseeing Ginnie Mae issuers concerning all matters related to participation in its mortgage-backed security programs, including monitoring issuer participation and executing issuer defaults.

Unlike banking institutions, nonbanks tend to have complex financial and operating structures and frequently use subservicers instead of servicing the loans in their portfolios. Additionally, nonbanks rely on credit lines for funding, which may limit a nonbank’s access to liquidity to meet the financial obligations of being a Ginnie Mae issuer. Banking institutions have standardized corporate ownership and lines of business, substantial liquidity, and the ability to service the loans in their portfolios.

Our audit objective was to determine whether Ginnie Mae responded adequately to changes in its issuer base. (3-4, charts omitted)

Unfortunately, the audit found that Ginnie Mae has come up short in dealing with the risks that it now faces. Time will tell whether it meaningfully responds to these deficiencies.