Capital Replacement Certificates: Possible QRM Solution for Smaller Shops?; Mortgage Interest Deduction Noise; Covered Bonds

We now live in a world with higher annual FHA premiums. Private MI companies, of course, are understandably quick to point out the price difference with the change. RMIC, for example, noted that "With this change, RMIC offers equal or lower monthly premium rates on all LTVs with no upfront premium. While FHA has been the choice of many lenders in the last few years, this rate increase and other recent FHA changes make this the ideal time to consider whether Private Mortgage Insurance (MI) is a better option for your high LTV borrowers." RMIC, and other MI companies, offers a site to compare premiums. MIComparison 

Auditing has become so bad that many large companies set aside a room, or block of them, for revolving teams of auditors from investors, Fannie, Freddie, the OTS, OTC, the FDIC, FRB, AA. (Ok, just seeing if you were really reading that list.) Last week the servicing biz was in the headlines, with the first official "enforcement." But in addition to those 14 servicing companies, LPS and MERS were both cited for "significant compliance failures" and "unsafe and unsound business practices" related to foreclosures. Regulators are requiring both companies to hire independent consultants, take remedial steps to address past failures and hire additional staff. LPS "faces the possibility of having to reimburse servicers and borrowers if an independent review finds anyone was financially harmed by its failure to properly execute mortgage documents" per an article by Kate Berry of American Banker. MERS said it is "already implementing changes to tighten corporate governance, improve internal controls and address quality-assurance issues identified by federal regulators."

A few months ago MERS, with its 31 million residential mortgages on its system, told members not to foreclose in its name since borrowers have filed so many suits claiming the company has no standing to foreclose even though MERS has been listed as the lienholder in many foreclosure filings. MERS has 30 days to hire a third party to analyze and assess its directors, officers, management and staffing needs, and 90 days to create a plan to establish adequate internal control, risk management, audit and reporting requirements. But regulators never questioned the underlying business model of MERS, or attempted to answer the question, "Does MERS have the legal right to foreclose on a borrower?" This has led industry watchers to suggest that MERS has, in effect, had its procedures and processes validated.

For the 14 servicers, the implementation of the steps necessary to comply with the consent orders will further weigh in on timelines and increase servicing costs. Companies already have to reallocate resources away from production and into developing and implementing the plans. The order contained more than 25 action items and detailed over 50 sets of new policies, processes, and measures that need to be developed and implemented over the next 120 days. The biggest change will be the establishment of a single point of contact for borrowers. In addition, servicers will need to hire and train additional staff. Longer term, the additional staff should help to work through the backlog of foreclosures in the pipeline. And the state attorneys general are still negotiating with servicers over a potentially more far reaching agreement. The consent orders may give servicers some leverage in their negotiations. However, until an agreement with the AGs is completed, a cloud is expected to remain over the foreclosure process. FULL STORY

The public comment period for the QRM rules continues at the Fed's website. But I've been asked what percentage of loans would pass QRM muster. Here is one report, straight from the regulator of Freddie & Fannie, thanks to Bill R. of Homeowners Financial Group in Arizona: FHFAQRM 

And this from a self-described "a humble sales guy trying to scratch out a living": "Rob, what am I missing? An independent mortgage banker makes $100 million of non-QRM mortgages....let's say 95% LTV FRMs.  The loans are securitized with Fred/Fan, but since they are out of conservatorship, the originator has to retain $5 million of 'skin in the game.' This would obviously constrict the balance sheet leverage of the mortgage banker.  It seems that someone could approach the mortgage banker, and offer to have the $5 million transferred to their balance sheet in exchange for a fee.  The mortgage banker could collect a fee on a prorated basis from the borrowers as he is originating the $100 million, a party still has skin in the game so the regulators should be indifferent and could dictate who is eligible to sell such 'capital replacement certificates' or whatever they will be called.  In essence, instead of selling MI on a loan by loan basis, an entity could take on the QRM risk on an aggregate level, and new secondary market trading 'QRM positions' will be created with cash flows, credit risks, product risks, geographic risks, counterparty risks, duration risks....all those things the quants love to measure, price, trade, re-trade, etc.

"There will be some creative new ways to meet the QRM regulations while bringing private capital to the market (good), providing product choices to the consumers (good) while keeping pricing to the consumers as low as possible (good) through the market based pricing of the risk of the transaction (good). I would guess that the MI companies or Wall Street firms are working on something ahead of the final rules being created - it is a form of the current guarantee fee structure." For more on QRM implications visit MND.

Occasionally, while out speaking to groups, I am asked, "How safe is the mortgage deduction?" In the past I was much surer of my answer ("Safe - what politician wants to take away even one of the advantages of home ownership?), but the noise in the press is growing too loud to ignore with articles every week on the subject. Whether eliminating it for 2nd homes, lowering the cap, or whatever, one can smell gradual change in the wind: InterestDeductionSacred? 

REIT's are garnering much of the press in the mortgage world right now. But we have other capital market "ideas" that companies are watching. One of these is the drive to restart Wall Street's securitization machine with instruments known as "covered bonds" which some feel will give private investors the comfort they need again. Covered bonds aren't new, and they're used extensively in other countries. They are pools of debt obligations that have been assembled by banks and sold to investors who receive the income generated by the assets. The bank that issues the bonds, meanwhile, retains the credit risk. If losses arise, the bank that issued the covered bonds must offset the loss with its own capital, letting investors sleep better at night but making banks "near the edge" that much more nervous. If an asset in the pool defaults, a separate entity would be required to remove the assets from the bank's control. The assets would then be out of reach of the FDIC should the bank fail and the agency step in as receiver. The investors who bought the covered bonds would have first call on the assets, ahead of the FDIC. Banks bypassing the FDIC? Don't bet on that happening in the US.

Today we've had Housing Starts and Building Permits, expected to improve but still provide more reminders about the slow state that housing is in. Housing Starts dropped sharply in February, led by a 46% drop in multifamily starts, and Permits hit a historical low. Why build more houses when there are so many old ones available? But expectations are for a rebound in March - how can we possibly have a healthy economic recovery without an improvement in the housing market? Yesterday's NAHB's Housing Market Index showed homebuilder sentiment remained low - surprising no one.

The pundits are still cogitating on Standard & Poor's statement on US debt, affirming its AAA long term rating but revising its outlook on the long-term rating from stable to negative. S&P stated that more than two years after the beginning of the recent crisis, U.S. policymakers have not agreed on a strategy to reverse recent fiscal deterioration or address longer-term fiscal pressures. Optimists believe that this rating change will give politicians a warning; pessimists feel that this doesn't change anything, and that the political bickering will continue. The negative outlook creates a steeper yield curve (the potential problems and uncertainty cause long-term rates, like 30-yr bonds, to move higher).

The problem is that any meaningful reduction in the deficit leads to the potential for greater fiscal drag on the economy, whether it is higher taxes or lower spending. These thoughts all went through the market yesterday, as interest rates actually dropped. The Treasury's10-yr closed better by about .250 and at a yield of 3.37%, and agency MBS prices improved by about .250. Stocks dropped, but Moody's reaffirmed its positive outlook on the United States. Today, as mentioned, we had Housing Starts at 549k, up from a revised 512k, and Building Permits for March went from a revised 534k to 594k, both higher as expected. And we already had Goldman Sachs' earnings, stronger than expected pretty much all the way around. The 10-yr is slightly better at 3.35% and MBS prices are roughly unchanged.

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