by Calculated Risk on 3/26/2008 12:45:00 PM

How many people think the new "temporary jumbo conforming loan limits" are really temporary?

Apparently the Office of Federal Housing Enterprise Oversight (OFHEO) does.

From OFHEO: OFHEO Issues Final Guidance on Conforming Loan Limit Calculations

The final Guidance addresses the handling of decreases in the house price data used to set the conforming loan limit as well as procedural matters relating to calculation of the limit that determines the size of mortgages eligible for purchase by Fannie Mae and Freddie Mac.

Based on comments received in two public comment periods, OFHEO is issuing a final Guidance that provides that the conforming loan limit would not decrease from its current level of $417,000 in 2009 and subsequent years. However, the conforming loan limit will not increase until cumulative increases in house prices exceed cumulative decreases since the $417,000 limit was first reached.

This means the conforming loan limit can never decrease, but it will not increase until prices have returned to earlier levels. Under the old guidance, the conforming loan limit was supposed to move with house prices, both up and down.

Of course, "temporary" probably means "permanent", and the limit will vary by MSA (Metropolitan Statistical Area).

by Calculated Risk on 3/19/2008 09:34:00 AM

Press Release: OFHEO, FANNIE MAE AND FREDDIE MAC Announce initiative to increase mortgage market liquidity

OFHEO, Fannie Mae and Freddie Mac today announced a major initiative to increase liquidity in support of the U.S. mortgage market. The initiative is expected to provide up to $200 billion of immediate liquidity to the mortgage-backed securities market.

OFHEO estimates that Fannie Mae’s and Freddie Mac’s existing capabilities, combined with this new initiative and the release of the portfolio caps announced in February, should allow the GSEs to purchase or guarantee about $2 trillion in mortgages this year. This capacity will permit them to do more in the jumbo temporary conforming market, subprime refinancing and loan modifications areas.

To support growth and further restore market liquidity, OFHEO announced that it would begin to permit a significant portion of the GSEs’ 30 percent OFHEO-directed capital surplus to be invested in mortgages and MBS. As a key part of this initiative, both companies announced that they will begin the process to raise significant capital. Both companies also said they would maintain overall capital levels well in excess of requirements while the mortgage market recovers in order to ensure market confidence and fulfill their public mission.

OFHEO announced that Fannie Mae is in full compliance with its Consent Order and that Freddie Mac has one remaining requirement relating to the separation of the Chairman and CEO positions. OFHEO expects to lift these Consent Orders in the near term. In view of this progress, the public purpose of the two companies, and ongoing market conditions, OFHEO concludes that it is appropriate to reduce immediately the existing 30 percent OFHEO-directed capital requirement to a 20 percent level, and will consider further reductions in the future.

by Calculated Risk on 3/18/2008 10:12:00 PM

From the WSJ: Fannie, Freddie Regulator Plans Capital Announcement

Ofheo for the past several years has required Fannie and Freddie to hold 30% more capital than their usual minimum while they have worked to resolve lapses in their accounting and internal risk controls, a process now viewed as largely complete. Ofheo is expected to reduce that capital "surcharge" initially to 20%.

The move should reduce Freddie's capital requirement by about $2.6 billion and Fannie's by $3.2 billion.

It wasn't that long ago when Fannie and Freddie were the problem, now they are the solution. The press conference is Wednesday at 9 AM.

by Calculated Risk on 3/03/2008 11:38:00 AM

From OFHEO: OFHEO, NY Attorney General, Fannie Mae and Freddie Mac Sign Agreements to Combat Appraisal Fraud

There are many significant provisions in the agreements that are designed to strengthen the independence of appraisers, including eliminating broker-ordered appraisals, prohibiting appraiser coercion, and reducing the use of appraisals prepared in-house or through captive appraisal management companies in underwriting mortgages. The agreements also enhance quality control in the appraisal process and establish a complaint hotline for consumers. The agreements include a Home Valuation Code of Conduct that the Enterprises will apply to lenders selling mortgages to Fannie Mae or Freddie Mac. The Code becomes effective on January 1, 2009.

The parties also agreed to establish and the Enterprises fund an Independent Valuation Protection Institute designed to supplement current efforts to provide an appraisal complaint process, mediation of appraisal disputes, and mortgage fraud reporting.

Tanta had some commentary last week: Fannie Mae New Rules for Appraisals

by Calculated Risk on 2/29/2008 01:41:00 PM

From St. Louis Fed President William Poole: Panel Discussion on Balancing Financial Stability, Price Stability and Macroeconomic Stability: How Important Is Moral Hazard?

We have known for many years that moral hazard is a potentially serious issue. If a firm believes that it will be bailed out if it gets into trouble, that expectation encourages excessive risk-taking and increases the probability of trouble. There are two complementary ways to deal with moral hazard. First, firms in trouble ought not to be bailed out, unless the bailout takes a form that imposes heavy costs on managers and shareholders. Second, firms subject to government regulation ought to be compelled to maintain adequate capital to reduce the probability of failure. U.S. banks entered the period of turmoil last year pretty well capitalized and have been able to withstand large losses.

I am more skeptical of the financial strength of the GSEs, and believe that we could see substantial problems in that sector. According to the S&P Case-Shiller home value data released earlier this week, as of December 2007 average prices had declined by 15 percent or more over the past 12 months in Phoenix, San Diego, Miami and Las Vegas. We can add Detroit to the danger list as the home price index for that city is down by almost 19 percent over the 24 months ending December 2007. With house prices falling significantly in a number of large markets, many prime mortgages issued a few years ago with a loan-to-value ratio of 80 percent may now have relatively little homeowner equity, which increases the probability of default and amount of loss in event of default.

As I emphasized some time ago, GSE losses will depend on the variance as well as the mean of changes in national home prices. Losses in markets with home prices falling more than the national average will not be offset by gains in markets with price changes above the national average. I do not have a new message here; we have known for a long time that advance preparation and a strong balance sheet are the keys to riding out a financial storm. As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues. I do not have any information on the GSEs that the market does not also have. Nevertheless, in assessing the risk of further credit disruptions this year, I would put the GSEs at the top of my list of sources of potentially serious problems. If those problems were realized, they would be a direct result of moral hazard inherent in the current structure of the GSEs.
emphasis added

Note that Poole is no longer a voting member of the FMOC. He concludes:

[A] financial firm cannot expect targeted aid for just the firms in trouble. An exception to this general statement is that, unfortunately, the GSEs probably can expect targeted aid. ... the GSEs ... might get assistance directly from Congress ...

by Tanta on 2/29/2008 07:18:00 AM

There has been some concern in our comments and on other blogs about this bit in Fannie Mae's 10-K published Wednesday:

Beginning in November 2007, we decreased the number of optional delinquent loan purchases from our single-family MBS trusts in order to preserve capital in compliance with our regulatory capital requirements. Although this change in practice may affect our cure rates, it has had no effect on our loss mitigation efforts and, based on current market conditions, is not expected to materially affect the “Reserve for guaranty losses.” We continue to purchase delinquent loans from MBS trusts primarily to modify these loans as part of our strategy to mitigate credit losses and in circumstances in which we are required to do so under our single-family MBS trust documents. Because we are continuing our loss mitigation efforts for delinquent loans, with a primary goal of permitting borrowers to avoid foreclosure, we do not intend to defer purchases of delinquent loans until we are required by our MBS trust documents to purchase the delinquent loans from our MBS trusts. Although we have decreased the number of our optional loan purchases, the total number of loans purchased from MBS trusts may increase in the future, which would result in an increase our SOP 03-3 fair value losses. The total number of loans we purchase from MBS trusts is dependent on a number of factors, including management decisions about appropriate loss mitigation efforts, the expected increase in loan delinquencies within our MBS trusts resulting from the current adverse conditions in the housing market and our need to preserve capital to meet our regulatory capital requirements. For example, we recently introduced a new HomeSaver Advance(tm) initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases. The credit environment remains fluid, and the number of loans that we purchase from our MBS trusts will continue to be affected by events and conditions that occur nationally and in regional markets, as well as changes in our business practices to respond to the current adverse market conditions.

This seems to have a bunch of folks concerned that what Fannie Mae is doing is making unsecured loans to borrowers just so that Fannie doesn't have to buy the loan out of the pool and take a fair value write-down. What it says, of course, is that Fannie Mae certainly intends this program, if it is successful, to reduce the number of mortgages that have to be bought out of the MBS, because the point of the program is to avoid having to do a formal modification of mortgage. If that is successful, it should, in fact, reduce the number of loans Fannie buys out of pools for loss-mitigation purposes.

It does not say that the sole intent of the program is to avoid fair-market write-downs on loans bought out of pools. This mention of this program just appears in the part of the 10-K that deals with pooled loan repurchases. I see nothing here that says that the HomeSaver Advance loans do not involve an increase in reserves for guaranty losses or an increase in the fair value of guaranty obligations (see page 54ff for an explanation of how accounting for credit losses, actual and expected, on MBS loans is handled), instead of an FMV adjustment to an owned loan. Perhaps the question came up in the conference call; I didn't listen to it. I would certainly expect that these loans can be expected to result in higher guaranty costs in the future, and should be accounted for accordingly. The point is simply that as the loans remain in the MBS, they do not appear in the category of loans bought out of MBS and therefore requiring an FMV adjustment under the infamous SOP-03. The reduction to income (increase in reserves) would happen elsewhere in the financials, under guaranty costs.

All that may be too geeky for you; if so I congratulate you on being a normal human being. Getting beyond the GAAP issues here, I think people just really want to know what this HomeSaver Advance thingy is. According to Fannie Mae's website,

HomeSaver Advance, an unsecured personal loan, is a new loss mitigation alternative available to approved Fannie Mae servicers for eligible borrowers designed to bring a delinquent loan current without a formal loan modification. It provides funds to cure arrearages of principal, interest, taxes, and insurance (PITI), as well as other advances and fees as listed in the Highlights section below. HomeSaver Advance is documented by a borrower-signed promissory note, payable over 15 years at a fixed rate of 5% with no payments or interest accrual for the first six months.

HomeSaver Advance is designed for qualified borrowers who have fallen behind on their mortgage, but are able to resume timely payments once their loan is brought current by the advance. It helps simplify and streamline the workout process for applicable loans, as it provides an option for earlier resolution of delinquent loans.

HomeSaver Advance Highlights

*Loan amount up to the lesser of $15,000 or 15% of the original UPB for delinquent PITI, escrow advances, and advances for attorney fees and costs and up to 6 months of unpaid HOA fees (12 months, where the HOA fee is paid once per year)
*Advances may not include late charges or other ancillary fees and costs
*The full loan amount is applied directly to arrearage (borrower never receives funds in hand)
*Truth in Lending Statement and unsecured promissory note are executed at time of agreement with borrower
*Note rate at a fixed rate of 5% with 6-month no-interest/no-payment period
*Amortization period of 14.5 years after the conclusion of the 6-month no-interest/no-payment period
*Workout fee paid to servicer is $600
*Fannie Mae will contract with a third party to service HomeSaver Advance promissory notes

The general rules for borrower eligibility:

• The mortgage is delinquent in an amount equal to or greater than two full payments of principal, interest, taxes and insurance;
• The mortgage must be seasoned with a minimum of six monthly payments made since the date of loan closing;
The mortgage may secure a principal residence, second home, or investment property—owner occupancy is not required; and
• The mortgage may generally be any type of loan (i.e., fixed-rate, adjustable-rate, interest-only, bi-weekly or daily simple interest).

HomeSaver Advance does not have a loan-to-value restriction or property valuation requirement.

Borrower Eligibility

Servicers must also ensure their borrower meets the following qualifications:
• The borrower has successfully resolved the reason for delinquency;
• The borrower demonstrates a long -term financial capacity to resume making the payments on the first mortgage loan and all other debts, including any subordinate mortgage loans (verbal confirmation of financial capacity is acceptable);
• The borrower has surplus income to support an additional monthly payment of at least $200 but does not have the ability to cure the arrearage using a repayment plan within a period of not more than nine months;
• The borrower is willing to participate in HomeSaver Advance; and
• The borrower does not currently have an outstanding HomeSaver Advance note; the HomeSaver Advance option may only be used once during the life of the particular first mortgage loan.

Borrowers involved in an active bankruptcy proceeding or who have had the debt previously discharged in a bankruptcy action are not eligible for this loss mitigation option.

So what does all that mean? First, it doesn't mean that this is how Fannie will handle all troubled loan workouts; it is one possibility. The rationale for this kind of thing--which isn't unheard of, by the way, for banks and other portfolio lenders, although it's new as far as I know for Fannie Mae--is that if you have a borrower with a fairly modest past-due amount ($15,000 or less) and you have determined that the cause of the delinquency was short-term and is now fixed (like temporary job loss), you could find that the effort and expense of buying a loan out of a pool and doing a formal modification of mortgage to add this modest amount can cost you almost more than it's worth. An alternative is just to make an unsecured loan for the past-due amount, while leaving the existing loan's terms unchanged.

It's risky, of course, because you aren't securing the make-up loan amount; that means that you can't take that amount out of foreclosure recoveries, and if the borrower declares bankruptcy your make-up loan just gets tossed into the unsecured bucket with the credit cards and such. The idea is that you would only do this if the amount in question were modest enough that it's not worth the expense to secure it. It seems completely obvious to me that it's not always worth rewriting a $200,000 loan to secure another $1,000. Another $15,000? That seems rather high to me as a ceiling for this program. But cost-effectiveness is the idea here.

I would also have tightened up the verification requirements for this deal. I realize that Fannie Mae clearly has some ability to collect from servicers if they misrepresent on the borrower's situation; I am, however, getting more and more jaded by the minute about conducting these things on a rep-and-warranty basis. I'd want written documentation of the borrower's cause of delinquency and financial condition, not verbal.

However, I don't necessarily think this is a terrible idea, with the above caveats in mind. Of course it all depends on how good you are at targeting it to borrowers whom it will truly benefit. (Do remember that these are Fannie Mae loans, not those horrible subprime exploding ARMs and stuff. They aren't perfect, but they're not the worst loans in the bunch to start with.) A couple of our commenters have suggested that it seems like no more than a way to throw away $15,000 on every delinquent loan you have. I don't think it's that bad, so I thought maybe we could go through an example--and it's just an example, not a prediction--of how the math would work in deciding to offer a program like this.

Let's start by assuming we have a pool of 100 loans that are eligible for this treatment. We'll assume the average loan amount is $200,000, the average interest rate is 6.50%, and the loans are all interest only (mostly so I don't have to keep amortizing balances, but also because that gives you a slightly worse case in recovery from future foreclosure, and I'm not trying to build an optimistic scenario). I'll assume that the servicer waives all attorney's fees and there's no HOA looking for money, so all we have to work with is past-due interest payments and escrow account contributions. The average monthly interest payment on these loans is $1083, and we'll say the average monthly escrow payment is $417, since that gives us a nice round $1,500 monthly payment to play with.

If all the borrowers are six months past due--which is a lot--then the unsecured loan amount for each loan would be $9,000. Plus Fannie Mae pays $600 a pop to the servicer for the workout fee, so if we did this on all 100 loans, we'd end up with $900,000 unsecured money at risk on a $20,000,000 pool at a cost of $60,000. You can, if you want, assume that all of these loans are underwater--the math works the same way--but for convenience I will assume that the $200,000 balance represents 100% LTV (the property is valued today at $200,000).

Therefore, if we had added the $9,000 to the loan amount via a formal modification, we'd have ended up with an LTV of 104.5%. Because we didn't secure the loan, our LTV stays 100%. Remember that since the additional money is unsecured, there is less disincentive for the borrower to sell the property at break-even; the lien can be released without the additional loan amount being paid in cash at the closing table. So from a voluntary prepayment perspective, these loans should perform just like any other once-delinquent loan at 100% LTV.

Let's further assume that our estimated losses on this pool (net of mortgage insurance and including FC expenses), if we foreclosed today instead of doing this workout, are 30%. That means that foreclosing them all right now would cost us $6,000,000. If you assumed that 100% of these loans would be permanently cured and all those borrowers would pay back all of the unsecured as well as secured money, it's obviously a deal to do this.

Of course we won't assume for a moment that these will be 100% successful. Fannie Mae reported in the 10-K that of the loans it has done modifications on that have a 2-year history since the modification was put in place, going back to 2001, 60% were performing or paid in full 24 months later, and 9% had been foreclosed 24 months later (the rest were still on the books but had become delinquent again, just apparently not delinquent enough to mean foreclosure yet). We are going to assume that that is much better performance than our workouts are likely to get, even though, if the program requirements are truly fulfilled, these HomeSaver Advance deals ought to perform better than your average workout (because they're supposed to involve true "temporary" situations and clear financial capacity to carry the payments).

We will assume that after two years, only 20% of our loans are either still cured and paying as agreed, or paid in full including the unsecured amount. We'll assume another 10% of the loans paid in full (the borrower sold the home or refinanced), but the borrower stiffed us on the unsecured amount and we have to write it off.

Of the remaining 70%, we will assume that 50% end up in foreclosure after 12 months, and the other 20% end up in foreclosure after 24 months. We do that because we want to take into account the possible costs of delaying foreclosure. That is always the problem with workout calculations. It's one thing to compare the cost of a workout to the cost of foreclosure today, but if the loan re-defaults, it may end up costing you more, because foreclosure losses next year might well be worse than they are this year. For our example, we'll assume that losses in a foreclosure would be 30% today, 40% in 12 months, or 50% in 24 months. (This is an example, not a prediction, remember. I'm not building in any positive effect of my workout efforts, although logically I should; the more loans I can permanently cure, the better the recovery should be on the ones I do foreclose because it means less REO inventory.)

That gives us 20 loans with no losses except our $600 fee to the servicer or $12,000. The 10 loans that paid in full on the mortgage but stiffed us on the unsecured loans generated a $96,000 loss. The 50 loans we had to foreclose after a year generated a $4,480,000 loss ($200,000 times 50 times 40% plus $9,600 times 50). The 20 loans we had to foreclose after two years generated a $2,192,000 loss ($200,000 times 20 times 50% plus $9,600 times 20). Total losses: $6,780,000, or 34% loss severity after two years instead of 30% loss severity by foreclosing them all today.

I think it's fair to say that it doesn't take much to think we could break even here. For one thing, it's probably not likely that all loans would be six months past due; if you figured only 4 months past due, which is still severely delinquent, you get 33% loss severity after two years (because the unsecured loan amount is smaller). Add 10 loans to the mortgage paid but unsecured loan written off group and take 10 out of the foreclosure after 12 months group, and you've actually got losses at 24 months at 29%, or just slightly better than foreclosing today.

My point is that you have to remember with workout calculations that while delaying foreclosure might increase the severity of loss on the foreclosures, you do save a lot of money on the ones you cure, and that offsets the calculations on an aggregate level. In practical terms, a program like this is just a lot faster and easier than the buy-loan-out-of-pool-modify-mortgage thing, and it's fair to count in the plus column the extent to which that frees up resources to work with the loans that don't qualify for this kind of deal (the ones that you'll have to do a full-blown mod on). Of course, you have to add back the fact that anything that's faster and easier is going to suffer from adverse selection problems--it does tend to be the lazy, cheapskate servicer's first choice of loss mit options even if it shouldn't be.

At the end of it, I think I'd say this isn't a terrible way to handle the workouts for those borrowers who were tight on mortgage affordability but not impossibly over their heads--say originally qualified at 42% DTI--and who therefore ended up several months past due after an incident (cut back on work hours, unforeseen medical expenses, that kind of thing) that would, in a less expensive relative to income housing cost environment, probably have been tolerable. As long as those borrowers are working with the servicer and want to hang onto the home, this gets them over the rough patch without raiding their retirement accounts or borrowing from the local loan shark, and I can get behind the wisdom of that, at least.

I don't think most troubled borrowers are necessarily in that situation--too many, sadly, are really in over their heads. But if you limit the HomeSaver Advance thing to the salvageable borrowers, you salvage those borrowers quickly and fairly cheaply, freeing up your real effort and expense for dealing with the much more troubled cases. So if that's what they're up to, I guess it's OK with me--not like they asked my opinion--but I do hope OFHEO is keeping an eye on this kind of thing for us, and that we all get to see some periodic reporting about how well this initiative is working out.

As far as the cynical view that this is just a way for Fannie Mae to avoid buying mortgages out of MBS? Doesn't everyone want them to limit their portfolio expansion? As long as they're accounting properly for the increased guaranty obligation here, why not leave the loans on the MBS's books?

by Tanta on 2/28/2008 08:17:00 AM

To refresh memories: Last fall, New York AG Andrew Cuomo sued an outfit called eAppraiseIt and its parent company, First American, for conspiring with WaMu to pressure appraisers to produce inflated appraised values. WaMu was not part of the suit, since for legal reasons state AGs can't sue federally-chartered thrifts in state court. Fannie Mae and Freddie Mac were not being sued either, but they were quickly served with subpoenas for documentation involving inflated appraisals on loans they may have purchased. The GSEs quickly agreed to appoint independent examiners to review appraisal practices, with the direct threat that lenders would be forced to buy back loans that failed to meet existing GSE rules.

It appears that Fannie Mae has finished or nearly finished its review, and is about to ruin several very large aggregators' and thousands of pissant brokers' day with a new set of rules regarding how appraisals can be obtained and what affiliations between lender and appraiser are acceptable:

Feb. 27 (Bloomberg) -- Fannie Mae, the biggest source of financing for U.S. home loans, told lenders it will probably ban their use of appraisals by in-house employees or those arranged by brokers.

Fannie Mae distributed the proposal, a response to New York Attorney General Andrew Cuomo's yearlong mortgage probe, to lenders in a ``talking points'' memo this week, according to a person familiar with the document. The memo was published on American Banker's Web site yesterday.

``It would be a monumental change because it would require a shift in the way that the lending industry does business,'' said Jonathan Miller, chief executive officer of Manhattan-based appraisal company Miller Samuel Inc. and a longtime proponent of creating a firewall between residential appraisers and mortgage originators. ``I think it would be tremendous.'' . . .

``Fannie Mae wishes to cooperate with the New York AG's investigation and, as part of a cooperation agreement, will likely agree to a number of items,'' according to the memo.

The proposed changes include banning Fannie Mae's partners from using appraisers employed by their wholly owned subsidiaries. Mortgage lenders that own appraisal companies include Countrywide Financial Corp., the nation's largest home- loan originator.

The restrictions would apply to loans acquired after Sept. 1, according to the memo. Fannie also told lenders that an independent appraisal clearinghouse likely would be established.

`Laughable' Practice

About three quarters of residential mortgage appraisals are arranged through brokers who only get paid if a loan closes, Miller said today in a phone interview. He called the practice ``laughable'' because it creates a financial incentive for mortgage brokers to push appraisers toward higher valuations. Higher appraisals also mean more homeowners qualify to refinance their homes and take cash out, he said. . . .

Cuomo spokesman Jeffrey Lerner said today in an e-mail that that Cuomo, Fannie Mae and Freddie Mac hadn't reached an agreement.

``We have had ongoing discussions for several months,'' Lerner said. ``At the end of the process, we will either have agreements or we will take other appropriate action.''

Cuomo prefers to pursue cooperative resolutions before litigating, Lerner said.

``We are continuing our discussions and we are making progress,'' said Corinne Russell, spokeswoman for the Office of Federal Housing Enterprise Oversight, which oversees Fannie Mae and Freddie Mac. . . .

Freddie Mac hasn't sent any memo similar to Fannie Mae's, said company spokeswoman Sharon McHale.

``We are cooperating fully with the attorney general's investigation, but at this point it would be premature to speculate as to what the outcome will be,'' McHale said.

Countrywide spokeswoman Ginny Zoraster declined to comment on Fannie Mae's proposals.

``The company does not believe this case has merit and expects to present a vigorous defense,'' Zoraster said in an e- mailed statement.

My observations:

1. So much for "synergy." I only hope that if this puts a stop to large lenders buying appraisal firms (and destroying appraiser independence), we can next move on to large lenders buying title companies (and destroying escrow officer independence).

2. Insofar as brokering of mortgages is going to survive this bust--and the indications are that any bank with a shred of sense right now is shutting down its wholesale division--they will go back to being application-takers, for which they will earn a modest fee. They will have a hard time maintaining their current pose of a "full-service lender" by also processing loans--including ordering appraisals, selecting a closing agent, etc.--which are a huge source of fees collected from consumers and which tend to give consumers the (false) impression that brokers are actually lenders.

What has been going on for some time now is that the massive failures in the wholesale model have forced the wholesale lenders to, in essence, redundantly process these loans, as everything the broker does has to be checked and rechecked and in some cases simply repeated. (You let brokers order appraisals, and once you get it, you order a second appraisal or field review appraisal or run an AVM in order to reality-check the appraisal you got. The process pretty much ceases to be efficient here.) If the GSEs just come out and force wholesalers to take control of the appraisal process from the very beginning, then the kabuki ends and we stop pretending that brokers are doing anything except bringing in a consumer willing to sign an application. The rest of the loan processing is turned over to the wholesaler.

3. An "independent appraisal clearinghouse" would, presumably, be intended to remove some of the problems I discussed in this post with individual lenders managing approved or excluded appraisal lists. Without details I can't really say what they're doing here, but it sounds like Fannie and Freddie are seriously considering getting into approving or excluding individual appraisers or appraisal firms. FHA has always done that in some fashion or another; the GSEs never have. That's a very substantial change to the way the GSEs do business with lenders.

by Tanta on 2/27/2008 01:31:00 PM

Some snippets from the Fannie Mae 10-K, if for some reason you didn't eagerly read the whole thing as soon as it hit the SEC website . . .

On losses:

We have experienced increased mortgage loan delinquencies and credit losses, which had a material adverse effect on our earnings, financial condition and capital position in 2007. Weak economic conditions in the Midwest and home price declines on a national basis, particularly in Florida, California, Nevada and Arizona, increased our single-family serious delinquency rate and contributed to higher default rates and loan loss severities in 2007. We are experiencing high serious delinquency rates and credit losses across our conventional single-family mortgage credit book of business, especially for loans to borrowers with low credit scores and loans with high loan-to-value (“LTV”) ratios. In addition, in 2007 we experienced particularly rapid increases in serious delinquency rates and credit losses in some higher risk loan categories, such as Alt-A loans, adjustable-rate loans, interest-only loans, negative amortization loans, loans made for the purchase of condominiums and loans with second liens. Many of these higher risk loans were originated in 2006 and the first half of 2007. . . .

We expect these trends to continue and that we will experience increased delinquencies and credit losses in 2008 as compared with 2007. The amount by which delinquencies and credit losses will increase in 2008 will depend on a variety of factors, including the extent of national and regional declines in home prices, interest rates and employment rates. In particular, we expect that the onset of a recession, either in the United States as a whole or in specific regions of the country, would significantly increase the level of our delinquencies and credit losses. Increases in our credit-related expenses would reduce our earnings and adversely affect our capital position and financial condition. . . .

On counterparty risk and the CFC-BoA merger:

The challenging mortgage and credit market conditions have adversely affected, and will likely continue to adversely affect, the liquidity and financial condition of a number of our institutional counterparties, particularly those whose businesses are concentrated in the mortgage industry. One or more of these institutions may default in its obligations to us for a number of reasons, such as changes in financial condition that affect their credit ratings, a reduction in liquidity, operational failures or insolvency. Several of our institutional counterparties have experienced ratings downgrades and liquidity constraints, including Countrywide Financial Corporation and its affiliates, which is our largest lender customer and mortgage servicer. These and other key institutional counterparties may become subject to serious liquidity problems that, either temporarily or permanently, negatively affect the viability of their business plans or reduce their access to funding sources. The financial difficulties that a number of our institutional counterparties are currently experiencing may negatively affect the ability of these counterparties to meet their obligations to us and the amount or quality of the products or services they provide to us. A default by a counterparty with significant obligations to us could result in significant financial losses to us and could materially adversely affect our ability to conduct our operations, which would adversely affect our earnings, liquidity, capital position and financial condition.

Our business with our lender customers, mortgage servicers, mortgage insurers, financial guarantors, custodial depository institutions and derivatives counterparties is heavily concentrated. For example, ten single-family mortgage servicers serviced 74% of our single-family mortgage credit book of business as of December 31, 2007. In addition, Countrywide Financial Corporation and its affiliates, our largest single-family mortgage servicer, serviced 23% of our single-family mortgage credit book of business as of December 31, 2007. Also, seven mortgage insurance companies provided over 99% of our total mortgage insurance coverage of $104.1 billion as of December 31, 2007, and our ten largest custodial depository institutions held 89% of our $32.5 billion in deposits for scheduled MBS payments in December 2007.

Moreover, many of our counterparties provide several types of services to us. For example, many of our lender customers or their affiliates also act as mortgage servicers, custodial depository institutions and document custodians for us. Accordingly, if one of these counterparties were to become insolvent or otherwise default on its obligations to us, it could harm our business and financial results in a variety of ways. . . .

Our ability to generate revenue from the purchase and securitization of mortgage loans depends on our ability to acquire a steady flow of mortgage loans from the originators of those loans. We acquire a significant portion of our mortgage loans from several large mortgage lenders. During 2007, our top five lender customers accounted for approximately 56% of our single-family business volume. Accordingly, maintaining our current business relationships and business volumes with our top lender customers is critical to our business. Some of our lender customers are experiencing, or may experience in the future, liquidity problems that would affect the volume of business they are able to generate. If any of our key lender customers significantly reduces the volume or quality of mortgage loans that the lender delivers to us or that we are willing to buy from them, we could lose significant business volume that we might be unable to replace, which could adversely affect our business and result in a decrease in our market share and earnings. In addition, a significant reduction in the volume of mortgage loans that we securitize could reduce the liquidity of Fannie Mae MBS, which in turn could have an adverse effect on their market value.

Our largest lender customer, Countrywide Financial Corporation and its affiliates, accounted for approximately 28% of our single-family business volume during 2007. In January 2008, Bank of America Corporation announced that it had reached an agreement to purchase Countrywide Financial Corporation. Together, Bank of America and Countrywide accounted for approximately 32% of our single-family business volume in 2007. We cannot predict at this time whether or when this merger will be completed and what effect the merger, if completed, will have on our relationship with Countrywide and Bank of America. Following the merger, we could lose significant business volume that we might be unable to replace, which could adversely affect our business and result in a decrease in our earnings and market share. . . .

On reserve calculations:

As the housing and mortgage markets deteriorated during 2007, we adjusted certain key assumptions used to calculate our loss reserves to reflect the rise in average loss severities, which more than doubled from 2006, and default rates. Prior to the fourth quarter of 2006, we derived loss severity factors using available historical loss data for the most recent two-year period. We derived our default rate factors based on loss curves developed from available historical loan performance data dating back to 1980. In the fourth quarter of 2006, we shortened our loss severity period assumption to reflect losses based on the previous year rather than a two-year period to reflect a trend of higher loss severities. Given the significant increase in loss severities during 2007 resulting from the decline in home prices, in the fourth quarter of 2007 we further reduced the loss severity period used in determining our loss reserves to reflect average loss severity based on the previous quarter. Additionally, for loans originated in 2006 and 2007, we transitioned to a one-year default curve and subsequently to a one-quarter default curve to reflect the increase in the incidence of early payment defaults on these loans. Statistically, the peak ages for mortgage loan defaults generally have been from two to six years after origination. However, our 2006 and 2007 loan vintages have exhibited a much earlier and higher incidence of default.

On the book of business:

Our conventional single-family mortgage credit book of business continues to consist mostly of traditional fixed-rate mortgage loans and loans secured by one-unit properties. Approximately 89% of our conventional single-family mortgage credit book of business consisted of fixed-rate loans, and approximately 96% consisted of loans secured by one-unit properties as of December 31, 2007. The weighted average credit score within our single-family mortgage credit book of business remained high at 721, and the estimated mark-to-market LTV ratio was 61% as of December 31, 2007.

Approximately 20% of our conventional single-family mortgage credit book of business had an estimated mark-to-market LTV ratio greater than 80% as of December 31, 2007. Of that 20% portion, over 62% of the loans were covered by credit enhancement. The remainder of these loans, which would have required credit enhancement at acquisition if the original LTV ratios had been above 80%, was not covered by credit enhancement as of December 31, 2007. While the LTV ratios of these loans were at or below 80% at the time of acquisition, they increased above 80% subsequent to acquisition due to declines in home prices over time. There was no metropolitan statistical area with more than 4% of these high LTV loans; the three largest metropolitan statistical area concentrations of these high LTV loans were in New York, Detroit and Washington, DC.

The most significant change in the risk characteristics of our conventional single-family business volume for 2007, relative to 2006 and 2005, was an increase in the percentage of fixed-rate mortgages acquired and a decrease in the percentage of adjustable rate mortgages acquired, driven in part by the shift in the primary mortgage market to a greater share of originations of fixed-rate loans. Fixed-rate mortgages represented 90% of our conventional single-family business volume in 2007, compared with 83% in 2006. Additionally, based on the higher risk nature of interest-only and negative amortizing ARMs, we significantly reduced our acquisition of these loans to less than 7% of our business volume in 2007, from 12% in each of 2006 and 2005. We anticipate relatively few negative amortizing ARM loan acquisitions in 2008.

The most significant change in the risk characteristics of our conventional single-family book of business as of the end of 2007, relative to the end of 2006, was an increase in the weighted average mark-to-market LTV to 61% as of December 31, 2007, from 55% as of the end of 2006. This increase was driven by a decline in home prices across the country, particularly in states such as California and Florida, which had previously experienced rapidly rising rates of home price appreciation and are now experiencing sharp declines in home prices.

In recent years there has been an increased percentage of borrowers obtaining second lien financing to purchase a home as a means of avoiding paying primary mortgage insurance. Although only 10% of our conventional single-family mortgage credit book of business had an original average LTV ratio greater than 90% as of December 31, 2007, we estimate that 15% of our conventional single-family mortgage credit book of business had an original combined average LTV ratio greater than 90%. The combined LTV ratio takes into account the combined amount of both the primary and second lien financing on the property. Second lien financing on a property increases the level of credit risk because it reduces the borrower’s equity in the property and may make it more difficult for a borrower to refinance. Our original combined average LTV ratio data is limited to second lien financing reported to us at the time of origination of the first mortgage loan. . . .

Alt-A mortgage loans, whether held in our portfolio or backing Fannie Mae MBS, represented approximately 16% of our single-family business volume in 2007, compared with approximately 22% and 16% in 2006 and 2005, respectively. During 2007, private-label securitization of Alt-A loans significantly decreased and Fannie Mae assumed a larger role in acquiring Alt-A mortgage loans; however, the actual amount of our acquisitions of Alt-A loans decreased in 2007 from 2006. In order to manage our credit risk in the shifting market environment, we lowered maximum allowable LTV ratios and increased minimum allowable credit scores for most Alt-A loan categories. We also limited our acquisition of some documentation types and made other types ineligible for delivery to us. Finally, we implemented pricing increases to reflect the higher credit risk posed by these mortgages. As a result of these eligibility restrictions and price increases, we believe that our volume of Alt-A mortgage loan acquisitions will decline in future periods.

We estimate that Alt-A mortgage loans held in our portfolio or Alt-A mortgage loans backing Fannie Mae MBS, excluding resecuritized private-label mortgage-related securities backed by Alt-A mortgage loans, represented approximately 12% of our total single-family mortgage credit book of business as of December 31, 2007, compared with approximately 11% and 8% as of December 31, 2006 and 2005, respectively. The majority of our Alt-A mortgage loans are fixed-rate, and the weighted average credit score of borrowers under our Alt-A mortgage loans is comparable to that of our overall single-family mortgage credit book of business. . . .

We estimate that subprime mortgage loans held in our portfolio or subprime mortgage loans backing Fannie Mae MBS, excluding resecuritized private-label mortgage-related securities backed by subprime mortgage loans, represented approximately 0.3% of our total single-family mortgage credit book of business as of December 31, 2007, compared with 0.2% and 0.1% as of December 31, 2006 and 2005, respectively. . . .

We have also invested in highly rated private-label mortgage-related securities that are backed by Alt-A or subprime mortgage loans. As of December 31, 2007, we held or guaranteed approximately $32.5 billion in private-label mortgage-related securities backed by Alt-A loans and approximately $41.4 billion in private-label mortgage-related securities backed by subprime loans. These amounts include resecuritized private-label mortgage-related securities backed by Alt-A and subprime mortgage loans.

On workouts:

Of the conventional single-family problem loans that are resolved through modification, long-term forbearance or repayment plans, our performance experience after 24 months following the inception of these types of plans, based on the period 2001 to 2005, has been that approximately 60% of these loans remain current or have been paid in full. Approximately 9% of these loans were terminated through foreclosure. The remaining loans continue in a delinquent status.

by Tanta on 2/27/2008 11:10:00 AM

OFHEO Press Release:

Fannie Mae published its timely, audited financial statement for 2007 today and Freddie Mac anticipates publishing its statement tomorrow. These steps constitute an important milestone in remediation of their respective operational and control weaknesses that led to multi-year periods when neither company released timely, audited financial statements.

Both companies have been operating under regulatory restrictions stemming from these past problems. These restrictions include growth limits on their retained mortgage portfolios, Consent Orders prescribing necessary remediation actions, and required 30 percent capital cushions above the statutory minimum capital requirements.

Mortgage Portfolio Growth Caps

In recognition of the progress being made by both companies, as indicated by the timely release of their 2007 audited financial statements, and consistent with the terms of the relevant agreements, OFHEO will remove the portfolio growth caps for both companies on March 1, 2008.

Consent Orders

Both companies have also made substantial progress with respect to completing the requirements of their respective Consent Orders. As each Enterprise nears completion, OFHEO is working with them to undertake a thorough review and validation of the completed work and will test the new systems and controls, as needed. To the extent that OFHEO finds the Enterprise has fulfilled the requirements of its Consent Order and the Enterprise has continued to file timely, audited financial statements, OFHEO will lift the Consent Order.

Fannie Mae has reported to us that its remediation activities under the Consent Order are nearing completion. Freddie Mac has completed most of the requirements under its Consent Order, but still faces the requirement of separating the CEO and Chairman position. Although not in the Consent Order, completion of the SEC registration process is a critical step.

OFHEO-Directed Capital Requirements

Since agreements reached in early 2004, OFHEO has had an ongoing requirement on each Enterprise to maintain a capital level at least 30 percent above the statutory minimum capital requirement because of the financial and operational uncertainties associated with their past problems. In retrospect, this OFHEO-directed capital requirement, coupled with their large preferred stock offerings means that they are in a much better capital position to deal with today’s difficult and volatile market conditions and their significant losses.

As each Enterprise nears the lifting of its Consent Order, OFHEO will discuss with its management the gradual decreasing of the current 30 percent OFHEO-directed capital requirement. The approach and timing of this decrease will also include consideration of the financial condition of the company, its overall risk profile, and current market conditions. It will also include consideration of the importance of the Enterprises remaining soundly capitalized to fulfill their important public purpose and the recent temporary expansion of their mission.

"And the recent temporary expansion of their mission." It does sound like Lockhart is still pissed about the jumbo thingy.

(Hat tip, bacon dreamz!)