Non-Agency Lending: How to Attract Private Funding to a Riskier Market

by devteam February 19th, 2011 | Share

ThernHouse Financial Services Committee conducted hearings on Wednesday onrnGovernment Barriers to the Housing Market Recovery, hearing from speakersrnrepresenting three government agencies and four representatives from the privaternand quasi-private sector.</p

DavidrnStevens, Assistant Secretary for Housing and Commission of the Federal HousingrnAdministration (FHA) told the committee that the Obama administration feels itrnis essential to facilitate the return of private capital to the mortgagernmarkets as the government scales back its current historically oversizedrnfootprint.  Stevens outlined the progressrnthat FHA has made in restoring its capital reserves, improving loan quality,rnand reducing its exposure to risk but said Congress needs to pass comprehensivernFHA reform legislation that enhances FHA’s lender enforcement capabilities andrnrisk management efforts. </p

The ObamarnAdministration’s recent report to Congress on housing finance reform set outrnthree options for such reform; the Administration believes FHA is the commonrnthread and must be part of facilitating the return of private capital and arnmore balanced national housing policy.</p

The firstrnoption would target government’s sole role in insuring or guaranteeingrnmortgages to creditworthy lower-and-moderate-income borrowers; leaving the vastrnmajority of the mortgage market to the private sector.  Option Two would complement the FHA role withrna backup mechanism to ensure access to credit during a housing crisis and thernthird option would include, alongside the FHA, limited government reinsurance ofrna targeted range of mortgage securities that would be designed to increasernliquidity and access and respond to future crisis. </p

Underrnthe first option the maximum loan size for FHA insurance would be reduced,rninitially by allowing the present increase in those limits to expire asrnscheduled this October 1.  FHA will workrnwith the Federal Housing Finance Agency (FHFA) to pursue increased pricing forrnguarantees by the government sponsored entities (GSEs) as well as additionalrnincreases for FHA insurance.</p

Stevensrnstressed that government cannot abruptly and prematurely withdraw its currentrnsupport without harming the housing market and severely affecting home prices.  Housing reform must also be pursued in a fairrnand equitable way so that all Americans have access to a choice of affordablernhousing and government must work to fix “the fundamental flaws thatrnoccurred at every link in the housing finance chain.”  These flaws allowed too much risk to buildrnand inflict severe harm on homeowners, lenders, investors, and the greaterrneconomy, but work is already underway through Dodd Frank and HUD’s work tornexplore alternative servicing compensation structures.</p

Stevensrnsaid that taking steps to ensure that Americans have access to an adequaternrange of affordable housing options does not mean that all Americans shouldrnbecome homeowners.  A national housingrnpolicy:</p<ul class="unIndentedList"<liWouldrnensure that people who are in a financial position to own a home have access tornthe capital needed to do so;</li<liGuaranteernthat families are not set up to fail with mortgages that enable them to buyrnhomes they simply cannot afford.</li<liAndrnit would make financing available to those who will build the rental housing neededrnto provide choices for the growing number of families for whom homeownershiprnmay not be the best option.</li</ul

Theodorern”Ted” Tozer, President, Government National Mortgage Association (Ginnie Mae) said therncurrent market in which the GSEs and Ginnie Mac guarantee 95 percent ofrnmortgage-backed securities is unsustainable. rnFor investors, uncertainty about the future of the GSEs impacts decisionrnmaking and as long as the GSEs offer an outlet for mortgage loans with belowrnmarket pricing, private label securities will be disadvantaged.  Current plans to increase GSE guarantee fees,rnincrease the capital ahead of the guarantees and wind own their investment portfoliosrnwill end uncertainty and create space for greater private sector investment.</p

Tozer said that the current private label securitization process worksrnwith limited oversight.  Bond trustees arerncurrently responsible only for distributing monthly interest and principalrnpayments to investors but, to restore trust and integrity to the market we mayrnneed to consider expanding their role and authority to include making surernloans are serviced properly.  They mayrnalso need authority to require repurchase of defective loans or to requirernissuers to cover catastrophic loss. </p

Panel II of the hearing consisted of testimony from Douglas Holtz-Eakin,rnPresident, American Action Forum; Michael A. J. Farrell, Chairman, President,rnand CEO, Annaly Capital Management, Inc.; Faith Schwartz, Executive Director,rnHOPE Now; and Julia Gordon, Senior Policy Counsel, Center for ResponsiblernLending.</p

Holtz-Eakin framed his remarks around two points:</p<ul class="unIndentedList"<liAdoption of appropriate housing finance polices will aid the pace ofrneconomic growth and job creation by stabilizing household balance sheets andrnclarifying single- and multi-family investment incentives;</li<liThere are good, pro-growth reasons to rethink the policy of supportingrndebt-financed owner-occupied housing through tax and regulatory subsidies.</li</ul

There are, he said, two channels by which housing finance policy will affectrnthe pace of economic growth; housing valuations and new constructionrnincentives. Housing values are under stress because of excess inventory; thernbest way to speed progress would be to get federal policy out of the way.  Valuations also depend on purchasers’ expectationsrnof future policies including deductibility of mortgage interest, subsidies forrnenergy-efficient investments, and guarantees for conforming mortgagernsecuritization.  Similar considerationsrnapply to how housing affects growth through construction.  Incentives to build depend on the expectationsrnfor low-income tax credits and other federal policies. The sooner both types ofrnpolicy decisions are made, the sooner housing will stop dragging on jobrncreation and growth.</p

Housing is heavily regulated; however the dominant federal policy isrnone that provides subsidies to the debt finance of owner-occupied housing.  Holtz-Eakin said the recent housing bubblernand current market conditions indicate that this has not served marketrnparticipants well and the committee should step back and answer key questionsrnabout the policy framework such as whether the government should subsidize anyrnhousing and if so, what type?  Should subsidiesrnbe provided directly to owners and renters or through builders and sellers ofrnproperties?  Should subsidies depend onrnthe mixture of debt and equity finance?  Will they be transparently displayed in the budgetrnand controlled by Congress or will the government continue to providern”virtually open-ended mortgage subsidies through the tax code and off-the-booksrnfinance subsidies via the GSEs?   </p

Farrell, whose company is the largest residential Real EstaternInvestment Trust on the New York Stock Exchange said that secondary mortgagernmarket investors provide 75 percent of the capital to the US housing market, arntotal of about $7.5 trillion in MBS.  Sincernthe country’s banks have about $12 trillion in total assets, there is notrnenough money in the banking system to fund the nation’s housing stock atrncurrent levels so it is axiomatic that a healthy securitization system isrnessential.  </p

At present the securitization market is attracting significant amountsrnof private capital to the securities with a government-wrapped but therncredit-sensitive non-Agency or private-label market is dormant with only onernsmall deal done in the last 2-1/2 years. rnThis market is not restarting because:</p<ul class="unIndentedList"<liThe math doesn't work. Eitherrnprimary mortgage rates have to rise, the rating agencies' senior/subordinaternsplits have to come down, and/or return requirements by the secondary marketrnhave to decline.</li<liThere is a higher yielding alternative; legacy private label MBS andrnseasoned loans that have been repriced by the market. </li<liIt is difficult sourcing enough newly originated loans. As a resultrnbanks have gotten comfortable with keeping non-conforming loans on theirrnbalance sheets but only after tightening underwriting standards. As long as these stringent standards remain,rnFarrell said, he doesn't see a vibrant private-label market developing.</li<liThere is uncertainty over the future regulatory environment related tornqualified residential mortgages and Basel III.</li</ul

The private label MBS market can come back to fill the credit gaprncurrently occupied by the GSE’s, he said, but not at the same price and not inrnthe same size.  Money Markets, mutualrnfunds, banks, foreign investors, and governmental agencies won’t invest inrnprivate label MBS because their investment guidelines preclude taking creditrnrisk.  “At the end of the day,”rnFarrell said, I have to refer back to my two market truths:  Securitization is the source of 75 percent ofrnthe capital to the housing market, and the private label securitization marketrnisn’t working right now.” </p

Schwartz said in order to create a climate in which investors willrnreturn to the markets there will have to be transparency, reliability, andrnmarket integrity.  There is a need forrnuniformity and clarity in such areas as servicing standards for mediation andrnfor the length of the foreclosure process. rnRepresentations and warranties must be clear and enforceable as mustrnborrower credit risk.  The price of lossrnmitigation needs to be assessed to ensure proper fee structures and external risksrnsuch as enhanced regulation taken into account. rn</p

Gordon offered a list of recommendations for Congress, Federal Agenciesrnand the states as well as a list of suggestions for improving the operations ofrnthe HAMP loan modification program.</p

Among her recommendations for Congress were:</p<ul class="unIndentedList"<liMandate loss mitigation prior to foreclosure</li<liLevel the playing field in court by providing legal assistance forrnhomeowners;</li<liProtect homeowners from the tax ramifications of mortgage debt forgiveness;</li<liChange the bankruptcy code to permit modification of mortgages onrnprincipal residences.</li</ul

Recommendations to federal agencies included:</p<ul class="unIndentedList"<liAggressively enforcing servicing rules, especially those related tornloss mitigation;</li<liThe new Consumer Financial Protection Bureau should make servicerrnoversight and enforcement a top priority;</li<liRegulators involved in creating the QRM exception should not impose arnhard down payment requirement for all borrowers.</li</ul

In addition to mandating loss mitigation prior to foreclosure, statesrnshould exercise supervisory and enforcement authority over servicers doingrnbusiness in their jurisdictions.

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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