The market is getting closer to a day when Fannie Mae and Freddie Mac could have a reduced presence in their market and trade their securities on a single platform while private capital makes a cautious return to the point where it more broadly meets borrower and investor needs, industry executives say. But they also say that there are still many steps to be taken before the industry can get there.
Clearly, the combination of government-sponsored enterprise platforms remains more a concept than a reality. Also lenders are still serving the market in many cases more narrowly than the government loan programs still dominating it call for due to their high secondary market and regulatory risk exposures.
At the Mortgage Bankers Association’s National Secondary Market Conference in New York, National Mortgage News held a roundtable discussion with top industry executives to comment on current and future trends affecting the business now and shaping its future.
Mark Fogarty, editorial director of the mortgage group at SourceMedia, moderated the discussion, which was organized by Bonnie Sinnock, managing editor for National Mortgage News. They were joined in the discussion by Brian Fitzpatrick, president and CEO of LoanLogics; Frank Pallotta, executive vice president and managing partner, Loan Value Group; Dave Hurt, vice president and regional manager, global capital markets, data and analytics, CoreLogic;
In this section of the roundtable, in addition to the viability of a single government-sponsored enterprise securities platform for Fannie Mae and Freddie Mac and the extent to which private capital has been able to return, participants discussed how securities buyer, sellers and lenders are interacting as the market shows signs of emerging from the housing downturn, with prices appreciating in many areas.
FOGARTY: Obviously, a lot of talk here about the single platform for securitization for Fannie and Freddie. What do you think about that? Good idea? Bad idea? Manageable? Unmanageable? Don’t all jump in at once!
HURT: Short answer is manageable and probably the best idea that’s out there right now. And I think you lose the duopoly, but that’s probably not a bad thing with the situation that they’re in. I would like to see some private sector involvement at least in the enhancement side of this thing so there’s less dependency on the government side. But there are a lot of smarter people than me, in fact, that are putting their heads around this thing and we’re trying to take an active role as well, at least in the design. But yes, the market needs it, is asking for it. The fact that you had a duopoly before and just maybe one is going to be good for the taxpayer, good for the originators.
FOGARTY: Economies of scale. You would think so.
PALLOTTA: Their missions are nearly identical, so I think that it would make the most sense, economies of scale from everything from legal to accounting to HR. Again, in the last five to eight years the missions have changed back to where it should be, which is to help homeowners get into their homes. So when they’re identical there’s no reason to have the two entities.
FOGARTY: So you’d be in favor of actually merging the two agencies as well as merging the two securitization platforms? Or would you not go that far?
IMURA: You should merge the platforms from the cost benefit. When you look at the escalating g-fees, it’s a way to mitigate them, because ultimately the redundancy is costing the market money and the more efficient it is, the better it is for the market.
HURT: I would say that essentially we have that today anyway. I mean there’s really not any differentiation, per se, on the g-fees and the reality of it is that they have to go up. And there has been a distinction between what FHA and Ginnie have done relative to what Fannie and Freddie have done at least on that side.
FOGARTY: Well, they’ve increased their fees as well.
HURT: There is delineation by product and design as such, and that’s going to continue.
FOGARTY: Do you see anybody replacing Fannie and Freddie? I’ve seen people asking for years. In other words, is there somebody—people say to me: “Oh, you know the REITS are big, they’re going to be the next Fannie and Freddie.” But you know the REITs aren’t obliged to make a mortgage the way Fannie and Freddie are. Lender of last resort, market maker—is there anybody that can replace them without having another government entity?
HURT: No one has that bottomless capital well to pull from the way the government can basically do. I don’t think, at least politically, that’s what they would like to see happen. I mean it would be such a blow to housing that you would lose that public support and just depend on the private sector. But there is a role, at least, for the private sector in that design, particularly in the credit enhancement side. And that needs to be vetted out and explored and probably developed.
FOGARTY: How would you describe that? What would that involve?
HURT: Not unlike the old wraps that used to be with the mortgage insurance companies, (like) on the nonagency type securitizations. You could create that kind of capability, but move some of that liability—if you will, accountability—to the government to the private sector. And certainly with the kind of collateral that’s being originated, this is high-quality stuff, so some of those risks that would have been associated with previous transactions have probably been muted if not taken off the table.
FOGARTY: Do you think investors are going to be happy with the AAA-rated instruments on nonconforming when the last batch exploded spectacularly? Do you think they will be gun-shy?
IMURA: I think they will be gun-shy up front, but over time there’s going to be more confidence in the modeling, because before when we got the rating agencies there was a lot of data that, looking back, you can understand the outcomes. You look at home price indexes for many years and they were positive. So there were many people surprised that they could actually go negative because the average was over 5% for multiple decades. It’s hard to mathematically come up with that scenario when the distribution was pretty thin on the curve. It turned out to be part of that distribution curb that did happen and did hurt the market.
HURT: Two things happened, not to say that they won’t happen again, but the likelihood of them happening again is slim. One of them is housing values moving as up and down as much as they did. We haven’t seen that since the big Depression—that sort of a move. So that’s one thing that is not necessarily ever going to happen again. We’re seeing some spikes in housing that at least people have to watch. But the other piece is if you watch what happened from 2007, particularly 2008, people were scrambling. If you were on the origination side you had pipelines, you had subprime loans that were scheduled for delivery, but all of a sudden those markets dried up. So guys were cleaning stuff out just to have a place to park them and sell them. I don’t think we’re going to go there again. There’s too much diligence that not only will be done, but can be done to eliminate that sort of crossing over, at least in that bucket I don’t see that on the horizon.
PALLOTTA: If you had to pick anything good that came out of the last four to five years, it’s exactly that. The phrase “Let the buyer beware” has never been more relevant. You need to count on your own due diligence, not just at the product level, but at the security level. And if you take a look at where the capital markets find interest, they will eventually find interest. There will be nonagency interest in the market. You need to look at predictability, cashflow, consistency of the asset itself. And what we’ve started to see is both of those. We’ve seen home prices start to pick up a little bit. It wasn’t a one-month or two-month blip, I think we’re probably headed for a little bit of a straight line. But we’ve also seen the unemployment situation get slightly better. Those are really the two things you look at as a security holder: consistency of cash flow and asset value and once you get that for an extended period of time you will start to see people stick their toes in the water. The yields that you’re seeing on nonagency residential paper are higher than the junk market. So if you really expand your view as to what the borrower is, a nonagency borrower who puts 30% down on a mortgage, who has the wherewithal from a DTI standpoint to make their payments—there’s no reason that they should be trading from an equivalent basis where a single-B junk credit should be trading. So there will be interest in the future, it will be a question of what everyone here has mentioned when you are finally comfortable with the type of due diligence that you do.
HURT: Frank makes a good point that when you have that level of due diligence and the pretty basic securitization process and the post-securitization process, there aren’t going to be any of the dependencies that used to be from all the intermediaries. Well, John Smith so and so is going to do 20% vetting on this pool. Everyone in that collateral chain is going to have invested skin-in-the-game interest and they are going to perform their own due diligence. As Frank said, “Let the buyer beware” is probably spoken in every circle and in every conversation. So they are all doing their own due diligence. Many of them are now their own best source of information rather than dependency on the intermediary, which you used to have in the past.
PALLOTTA: It’s the first time you’re seeing “seller beware,” too. With the regulatory environment being what it is right now I think banks, MIs, rating agencies, and investment banks that would eventually issue securities, they’re going to do due diligence to make sure whatever they are putting out the door goes well beyond what the profit potential is.
FITZPATRICK: One of the key things when you look at in the new securitization framework as it is proposed in the new utility, it’s certainly about granularity and transparency in a securitized or post-securitized type market being able to monitor those loans. But what really has to be addressed is the manufacturing quality before we even get to that point. They shouldn’t wait to be validated when it gets into that utility. Data has to be validated all the way up front. When Fitch came out with their white paper...they were talking about how important it is to have quality at the very frontend of the process. So, as important as I think it is to have the single utility relative to maintaining the quality and validating the quality and enforcing the transaction after securitization, it is also important that we focus on the manufacturing qualities before it even gets to that point. Because if you’re manufacturing garbage from the start, all you’re doing is catching the garbage and a lot of times it’s too late to fix the garbage when you’re at this point in the securitization framework. So that’s the part that not everybody is talking enough about leading up to the point where you say “buyer beware/seller beware.” It’s creating better quality throughout that process all the way to the point where we’re selling this loan.
IMURA: Brian, I agree with you. This all comes at a cost to the market. Because when you look at origination costs and servicing costs, those have gone up. And from the crisis we’ve gone more to a vanilla product in the mortgage market. You know it used to be many different flavors. And as the market recovers and there are signs of the purchase market coming back, because when home prices are reported in headlines as going up what you’ll find is the buyer wants to come back into the market. For a while there was a conventional thinking that renting was smarter than owning and that was a short-term blip in the economic cycle because over time we expect home prices to go up.
HURT: You’re actually seeing that in the inventory that’s out there. A lot of the people we’re talking to, I live in the Washington, D.C., area, and it’s not necessarily a case of days on markets, sometimes it is hours on market because there’s just not that much inventory. And even on the building side, with them trying to bring product, they’ve lost a lot of the crews that would normally do the work: dry wall, studs, whatever. So some of that’s been delayed and it’s just not meeting the demand that’s out there.
FITZPATRICK: That’s a good point, Dave, but one the other critical factors is that there are people suffering from empty mailbox syndrome that shouldn’t be. There are people in the credit spectrum that, if you look at how long the credit cycle has driven out (the loan closing), and you look at the average FICO and the LTV this was pristine paper before. So, we have this issue of a lot of credit overlays being laid on top of the traditional, conventional Fannie, Freddie product and even FHA. You look at the FICO scores of an FHA loan—it’s not what FHA was designed to do. I mean, it’s very good quality paper. So in addition to us seeing buyers wanting to enter the market, there are folks that just can’t get a mortgage because of the fear that, quite frankly, lenders are placing on top of the Fannie and Freddie products. So enter additional secondary market participants: We have to open up the credit spectrum. And I am not talking about the days of subprime. I am talking about just opening up the credit spectrum to the folks who shouldn’t be suffering from empty mailbox syndrome. They can’t get a loan.
HURT: You make a good point there, Brian. Clearly there’s a gap there. Because they can meet all the requirements of QM, but still not be qualified for a loan in the nonagency sector. And it’s a problem.
STURGES: Well the risk is being put on the lender. And the lender has had to add their own overlays. Consequently the borrower from 650-700 has been closed to the market credit-score wise.
