Slowing down VA refi churn proving more difficult than expected

Ginnie Mae officials continue to be concerned about the high prepayment speeds of Department of Veterans Affairs-guaranteed mortgages.

Specifically, cash-out refinance VA mortgages with minimal seasoning "are prepaying at rates that are inexplicably high," said Michael Bright, who's serving as acting president of Ginnie Mae while he awaits congressional approval to permanently fill the role.

"It makes no economic sense," he added, as mortgage rates have risen over 75 basis points since the start of the year. "There are some anomalous characteristics here, one of which being this spike in refinance activity is happening right at month seven."

Ginnie Mae is now searching for the reason. One possible explanation for the seven-month timing is that regulatory changes earlier this year require borrowers to have a six-month payment history before refinancing into a new VA loan. It's also unclear if the refi activity is concentrated around certain types of mortgage lenders.

Churning has been an ongoing issue for the VA program. Earlier this year, some lenders were restricted from issuing new Ginnie Mae mortgage-backed securities that included VA-guaranteed mortgages. But that was not related to the agency's current concerns with the cash-out refis, Bright said.

Liquidity is an issue if the churning goes unchecked. Investors are likely to have concerns about buying more Ginnie Mae bonds until the agency gets a handle on this issue.

VA mortgages made up 19.1% of the $38.2 billion of Ginnie Mae MBS outstanding back in the second quarter of fiscal year 2008. They were 42.7% of the $96 billion outstanding 10 years later.

"Investors want a bond with some predictable cash flow and if loans prepay out of a pool seven months after they were already refinanced, that's a very unpredictable cash flow in a rising rate environment," said Bright.

That possible reduction in liquidity affects the ability for borrowers in other government lending programs to get a loan, Bright said. Even veterans could find it difficult to get a mortgage. "So the systemwide domino effect is not good," he continued.

The situation is also alarming because it could signal predatory or misleading behavior by lenders against veterans. While Ginnie Mae doesn't have regulatory authority over predatory lending, it is alerting other agencies that do, specifically the Consumer Financial Protection Bureau.

The shift in the Ginnie Mae issuer base from banks to nonbanks is not a contributing factor, Bright added. "That shift, which has been going on for several years, is not what is driving the increase in prepay speeds."

But nonbanks' capitalization, which now make up the larger share of Ginnie Mae issuers, was a large concern of Bright's predecessor, Ted Tozer.

As origination volumes slow, lenders are looking to make up the fee income. "Independent mortgage bankers are kind of a one-trick pony," said Tozer, currently a senior fellow at the Milken Institute. "They're not like banks that have other operations like credit cards or car loans that can supplement the revenue they're losing" with less origination activity.

As a result, some nonbanks "may feel tempted to push the envelope on some of the rules and so forth that are out there just to stay financially viable."

For now, Ginnie Mae should remain cautious about those prepayment speeds.

Dodd-Frank reform was signed into law in May, so "it is also important for everybody to wait a month or two just to see how volume shakes out," Tozer said.

There is a lag time as the payoff that occurs in October is for a loan that closed in September, and the application would have been taken in June or July. "So it's a long tail to see these prepayments," so Ginnie Mae should monitor if there is a slowing in the speeds in a few months, Tozer said.

When someone buys a home, the transaction goes into public land records. "And once it becomes public record, there are a number of different companies out there that aggregate the data and then focus very aggressively on refinancing the veteran," said Grant Moon, CEO of Home Captain, a service that helps shepherd consumers through the home buying and finance process.

Home Captain is a veteran-owned lender (Moon is an Army veteran who served in Iraq) and it employs military spouses; approximately 30% of its clients are vets.

"I know myself, being a veteran, any time I've ever bought a home using a VA loan, the mail starts pouring in. It looks like it's officially coming from the VA or the military or something else," he said.

Even with his experience in the mortgage industry, Moon said it can be hard for him to discern whether these marketing materials are legitimate or not.

There could be reasons why a borrower would refi quickly in a rising interest rate environment. "It depends on the individual situation. If they've maxed out their credit cards and they can take cash out to pay them down, it's better than paying a 20% interest rate on credit cards," said Moon.

But some people might decide to a refi thinking they got a special offer from the government and "that's a different story."