As the secondary market rethinks risks, so too must lenders

From the start, the Biden-era Federal Housing Finance Agency has been focused on its public mission, but now that the pandemic has receded it’s additionally assessing the government-sponsored enterprises’ risks in line with an exit from conservatorship.

That process primarily occurs at the enterprise level with the aim of setting capital requirements for the GSEs, but it also has a ripple effect: When Fannie and Freddie reassess their risks and change their policies, lenders often have to as well.

Notably, at deadline the FHFA was in the midst of vetting comments on re-proposed counterparty standards for housing finance firms. In addition, ongoing mission-related borrower policy updates, such as new GSE criteria for mortgage underwriting and title, may require new assessments of risk on the part of lenders selling their loans to Fannie and Freddie as well as the enterprises themselves.

What follows are some of the types of risk housing-finance companies may have to rethink as Fannie, Freddie and the FHFA do and ways lenders can go about assessing them.

Liquidity

The market dislocation early in the pandemic was a key driver in the FHFA’s decision to rethink a planned update to its minimum counterparty standards.

Some experts have referred to the new proposed liquidity requirements as on a net basis as high enough to be a concern for certain lenders even though the FHFA did provide some leeway. For example: While the proposed standards would allow mortgage companies working with Fannie and Freddie to avoid incremental charges related to having high levels of nonperforming loans, they also add a new origination liquidity requirement equal to 2% of lenders’ outstanding hedging position. These types of elevated liquidity requirements could create a need for new risk assessments around this requirement for nonbanks in particular.

“While it is prudent for the GSEs to periodically review and assess their counterparties regarding their financial stability and capabilities to stand behind their financial obligations under their agreements, unilaterally applying these standards to banks and nonbanks could create an unlevel playing field in favor of the banks,” said Tom Piercy, president, national enterprise business development at Incenter Inc., in an email.

However, experts expected last month that the regulatory agency could tweak its liquidity requirements to make them more manageable in response to feedback.

In anticipation of whatever the final standards might be, mortgage companies might want to  take stock of what they can or may be able to count toward liquidity under different scenarios. Some commentators have suggested that if the FHFA doesn’t back down from its higher liquidity standards in its final revision, it could potentially provide some flexibility in how companies address them. The FHFA could, for example, allow collateral from outstanding servicing-advance lines to be counted toward fulfilling liquidity requirements.

“The measurement would have to be, not that I've got, say, $250 million left on a line, but I've gotta have the actual collateral in hand in order to borrow that money,” said Ed DeMarco, president of the Housing Policy Council and a former FHFA official, in an interview.

Title

Fannie Mae’s decision to join Freddie Mac in allowing limited leeway for certain title insurance alternatives has prompted speculation that attorney opinion letters could be more broadly used in conjunction with refinance loan sales to the GSEs, but that may depend in part on lenders.

Lender acceptance of the letters could further the GSEs’ affordable housing mission if it lowers costs for borrowers the way vendors say it sometimes can, but one industry group has warned they may not mitigate the risk that title could be clouded as well as traditional insurance does.

Considerations in sizing up the risk of the letters as an alternative to insurance include the fact that an attorney’s opinion doesn’t necessarily cover title risks that aren’t apparent in public records such as those resulting from fraud, according to the American Land Title Association.

“Title insurance…covers risks that might be missed by the attorney or examiner, which is [a] critical distinction from a written attorney opinion, where the attorney is only potentially liable for negligence,” according to ALTA.

While ALTA and vendors that support attorney opinion letters disagree on which does a better job of managing risk relative to the cost, the one thing they and the GSEs agree on is that it’s necessary to pick your spots if using the letters, which Fannie does flag as outside the norm.

In some cases, it’s not even a matter of choice and sizing up risk given existing GSE rules prohibit some uses, such as when loans are secured by properties that are part of a homeowners association, ALTA noted.

Assessments of the title risks on loans are available from companies like iTitleTransfer. It uses a scale of one to three, which rises in line with risk, and it recommends lenders get insurance to cover anything higher than a two.

“A one is super clean. A two probably needs some curative action. A score of three means that this one's messy and my company doesn't want to be involved. We close our file and we refer the loan to a title company,” said Theodore Sprink, managing director at the company, in an interview.

Alternative payment histories

Fannie Mae has started incorporating consumer rent-payment histories into its automated underwriting system for certain entry-level homebuyers that can verify information through a year’s worth of bank data, so lenders are looking more closely at what the risk in getting involved in this type of credit assessment is for them.

Generally, experts have said that if a devil exists in this area, it’s in the details.

“I think there could be challenges with regard to how to do this and to validate the data, but I think anything provides consumers more options to be able to validate their credit histories, particularly those who are first-time home buyers and maybe haven't established real credit, is helpful,” said Mike McPartland, a senior managing director at consultancy Reference Point, in an interview. 

Inconsistencies in amounts and verification challenges like payments made to roommates are among the complications Fannie anticipates in some of its policies, and are among the risks lenders need to assess. 

“It's the heavy lift of trying to verify rent that's been an issue in the past,” noted Vicki Bott, a director leading housing-finance advisory services at Reference Point. “On the banking statements, it could be their rent's $1,450 and but they may pay $1,251 one month where someone might say, ‘They gave me a discount because I fixed the fence’ or something like that.”

However, while Fannie is just starting to offer this type of underwriting and some kinks will need to be worked out, the general concept of using rental-payment data for this purpose has been around long enough that it’s becoming increasingly reliable.

“When it comes to being able to validate debits out of a consumer’s account, or credits into a landlord’s, that information is so much more readily available than it was years ago, so certainly I think there's real opportunity to be able to validate rent data to the comfort of lenders,” said McPartland, who is a former managing director for both Citigroup and JPMorgan Chase's residential lending divisions.