“A Crack in The Foundation?” Part 1: Fannie & Friends — The Evolution of Mortgage Policy from 1930-1960
Welcome to “A Crack in the Foundation?”, a four-part series in which Maxwell Digital Mortgage Solutions will examine the evolution of the mortgage industry and homeownership in America, with an eye on government policies and how GSEs can promote (or prohibit) periods of economic growth.
Part I starts at the turn of the 20th century and traces the establishment of the Federal Housing Administration (FHA), as well as the birth of Fannie and Ginnie, to look at the inception of the modern mortgage and its impact on home ownership.
(Source: by Victor Whitman | Scotsman Guide) Changes are likely to come soon that will make it harder for prospective borrowers to obtain Federal Housing Administration (FHA) loans. It’s all part of an effort to dial back loosening credit standards that have seen FHA borrower debt loads and cash-out refinancing activity rise to record levels, top officials with the U.S. Department of Housing and Urban Development (HUD) told reporters on Thursday.
“We will be making some additional changes soon,” said FHA Commissioner Brian Montgomery during a morning conference call. HUD released its fiscal 2018 annual report to Congress on the health of the FHA insurance fund.
“I couldn’t give you an exact date, but again we want to find that critical balance between providing people with the opportunity for sustainable home ownership, but again we have to maintain the right balance and protect taxpayers against risk.”
Montgomery didn’t reveal any specific plans on where the tightening may occur, but indicated cash-out refinancing activity was in the cross-hairs of the agency.
In a year where refinances dropped dramatically, FHA’s cash-out counts rose 6percent, to 150,883, in fiscal 2018.
“Cash-out refinances, both as a percentage of our over all business and our refinance endorsement volume, are growing astronomically,”Montgomery said. Cash-out refinances comprised nearly 63 percent of all refinance transactions in fiscal 2018, up from nearly 39 percent last year, he said.
“The increase in cash-outs presents a potential future risk for us, but also challenges the core tenants of FHA’s taxpayer-backed mission.”
Montgomery said rising debt-to-income (DTI) ratios are another major concern.
“Almost a quarter of our forward-purchase business was comprised of mortgages in which a borrower had a DTI ratio above 50 percent,”he said. “That is the highest percentage since 2000. When you couple that with a trend of decreasing average credit scores — 670 this year versus 676last year and the lowest average since 2008 — most underwriters and housing-finance experts will say that managing this type of risk without corresponding scrutiny becomes problematic.”
Montgomery also said HUD has concerns about the jurisdictional right and the extent to which government entities, such as state housing-finance agencies, provide down payment assistance to FHA borrowers.
Montgomery also indicated that HUD will not be cutting FHA insurance rates in the near future.
“While the [insurance] fund is sound at this point in time,I think we are still far away from being in a position to consider any reduction in our mortgage-insurance premium,” he said.
HUD’s insurance fund ended the 2018 fiscal year in September in better shape than the end of fiscal 2017. The net worth of the fund increased to $34.9 billion, up $8.12 billion at the end of fiscal 2017. The fund’s capital ratio, a closely watched metric that compares the net worth of the fund to the dollar balance of all active insured loans, stood at a 2.76 percent, up from 2.18 percent at the end of fiscal 2017. This was the fourth-consecutive year that the capital ratio has been above Congress’s mandated 2 percent threshold, a level it considers sufficient to sustain losses without government intervention.
The overall fund, however, was once again dragged down by FHA’s reserve-mortgage program, known as the Home Equity Conversion Mortgage (HECM). Reverse mortgages are loans that allow seniors to tap their home equity and remain in their homes for life. They represent a small portion of all FHA-insured loans, but have had an out sized impact on the risk to the fund.
The FHA portfolio of HECM-insured mortgages was estimated to have a negative value of $16.3 billion. The reverse portfolio also had a negative capital ratio of 18.83 percent.
By contrast, FHA’s regular forward-loan portfolio — loans commonly taken out by first-time home buyers — had an estimated positive value of $46.8 billion and a healthy positive capital ratio of 3.93 percent.
Montgomery and HUD Secretary Ben Carson, who also joined the morning call with reporters, said that elderly borrowers in the reverse program are being subsidized to an unsustainable degree by the typically lower-income,often minority, first-time home buyers in the FHA’s forward-loan program.
“We are committed to maintaining a viable HECM program, so seniors can continue to age in place, but we can’t continue to see future HECM books being subsidized by our forward-mortgage programs,” Montgomery said. “It is not beneficial to anyone, including taxpayers.”
HUD has taken steps to tighten the program already,including most recently requiring a second appraisal on homes where the value could have been inflated. Montgomery said FHA is working on a plan to conduct a census of all families who live in homes with a HECM mortgage.
Mortgage Bankers Association President Robert Broeksmit said HUD’s scrutiny of FHA’s credit standards was “prudent.”
“We are glad to see that FHA is closely monitoring the increasing risk in the forward portfolio, indicated by rising debt-to-income ratios, declining credit scores, and the increasing use of down payment-assistance programs,” Broeksmit said. “While current FHA delinquencies are quite low, it is prudent to keep an eye on these trends to ensure the program does not face undue challenges if, and when, the economy and job market cool.”
Broeksmit also noted that MBA has previously drawn attention to the HECM portfolio’s drain on the fund, and supported recent tightening moves.
“Policy makers should continue considering ways to insulate the forward program from the volatility in the reverse program,” he said.
That HUD might crack down on FHA-lending standards is worrisome for non-banks, however. Non-banks are now originating the bulk of FHA loans today. Reacting to the report, non-bank trade group the Community Home Lenders Association (CHLA) said HUD should loosen restrictions on the program by eliminating an Obama-era requirement that borrowers hold FHA insurance for the life of the loan.
“CHLA also renews its call for a cut in annual premiums, a move justified by FHA’s strong financial performance,” CHLA Executive Director Scott Olson said.
Fannie Mae and Freddie Mac are bankrolling significantly fewer loans this year, reflecting the general slowdown in the residential U.S. mortgage market.
In the nine months through the third quarter, the government-sponsored enterprises (GSEs) purchased a combined 2.47 million home loans, down 9 percent for the same nine months in 2017, the companies reported last week in quarterly reports.
The GSEs bankroll around 45 percent of all residential mortgages, according to the Urban Institute, by purchasing loans from lenders, wrapping them with a government guarantee and securitizing most of them for sale in the secondary market.
The combined balance of these loans through the third quarter was $577 billion, down 7 percent from the 2017 level for the same nine months.
GSE funding activity has dropped for the second consecutive year.
The 2018 year-to-date counts and volume balances were down 16 percent and 15 percent, respectively, compared to same nine months in 2016.
During a conference call last week, Fannie Mae Chief Financial Officer Celeste Brown alluded to tough conditions for lenders.
“At a high level, what I see is that our customers are facing a lot of headwinds in the market,” she said. “Rates are up, volumes are down, and margins are tight, so lender profitability is challenged. New housing supply is up but not all the supply has been created where it’s needed. While we do see income growth nationally, in many markets home-price growth has outstripped income growth so affordability for home buyers remains a challenge,” Brown said.
The numbers have waned as a result of the big drop in refinancing activity. The combined GSE refinance counts totaled 909,000, down 26 percent from the 1.23 million refinance loans acquired by the GSEs through the first nine months of 2017. The GSE reports indicate that cash-out refinancing levels have remained fairly stable, whereas rate-reduction and term refinances are falling steeply.
Meanwhile, the home-purchase market hasn’t grown at anywhere near the pace that refinance activity has been falling.The combined GSE home-purchase loan counts through the third quarter totaled 1.56 million, up 5 percent over the 2017 level.
U.S. home sales are expected to be flat this year or even decline marginally due to rising prices; a lack of affordable, entry-level homes for sale; and rising rates.
“Our expectations for housing have become more pessimistic,” Fannie Mae Chief Economist Doug Duncan said in October. “Rising interest rates and declining housing sentiment from both consumers and lenders led us to lower our home sales forecast over the duration of 2018 and through 2019. Meanwhile, affordability, especially for first-time home buyers, remains atop the list of challenges facing the housing market.”
Fannie Mae’s most recent forecast calls for the origination volume for the entire market to fall 10.5 percent year over year in 2018, to $1.63 trillion. Refinance volume is predicted to decline by 30 percent over the 2017 level to $454 billion. Purchase volume in 2018 will remain essentially flat with the 2017 level at $1.18 trillion, Fannie forecasts.
The Department of Housing and Urban Development on Tuesday will formally announce plans to increase premiums and tighten lending limits on reverse mortgages, citing concerns about the strength of the program and taxpayer losses.
Mortgage insurance premiums on Home Equity Conversion Mortgages will rise to 2% of the home value at the time of origination, then 0.5% annually during the life of the loan, The Wall Street JournalreportedTuesday morning. In addition, the average amount of cash that seniors can access will drop from about 64% of the home’s value to 58% based on current rates, the WSJ said.
“Given the losses we’re seeing in the program, we have a responsibility to make changes that balance our mission with our responsibility to protect taxpayers,” HUD secretary Ben Carson told the WSJ via a spokesperson.
The HECM program’s value within the Mutual Mortgage Insurance Fund waspeggedat negative $7.72 billion in fiscal 2016, and the WSJ noted that the HECM program has generated in $12 billion in payouts from the fund since 2009. The value of the HECM program fluctuates over time, however: In 2015, the reverse mortgage portion of the fund generated an estimated $6.78 billion in value; in 2014, the deficit was negative $1.17 billion.
Unnamed HUD officials told the WSJ that without this change, the Federal Housing Administration would need an appropriation from Congress in the next few years to sustain the HECM fund. The officials also said that the drag created by reverse mortgages has prevented them from lowering insurance premiums on forward mortgages for homeowners.
“You have this cross-subsidy from younger, less affluent people who are trying to achieve homeownership,” HUD senior advisor Adolfo Marzol told the WSJ.
The move took the industry by surprise, with the WSJ reporting that leaders were not briefed on the changes beforehand.
Big banks have drastically reduced their share of the Federal Housing Administration market, a massive shift that has big implications, according to new analysis by the American Enterprise Institute.
Large banks — which had a 60% share of FHA refinancings in late 2013 — had a 6% share as of May 31, according to Stephen Oliner, a resident scholar at AEI. Nonbank lenders currently originate 90% of FHA-insured refinancings, according to new data released by the group.
Large banks also had a 65% share of the FHA purchase market in 2012, which is now down to 20%, according to AEI.
“The shift away from large banks to non-banks and mortgage brokers has been truly massive,” Oliner said.
The recent drop in interest rates is expected to spur another surge in refinancings due to Britain’s unexpected decision to leave the European Union.
But the large banks have decided that refinancing FHA loans is “not a good business” due to the regulatory environment and litigation risk, Oliner said.
“They are getting out,” he said, noting that many FHA lenders have been sued under the False Claims Act and had to pay huge fines to the Justice Department.
Banks also don’t get Community Reinvestment Act credit for refinancings. “So this is pretty much a lose-lose business for them,” Oliner said.
The purpose of the Federal Housing Administration is “to help creditworthy low-income and first-time home buyers“, individuals and families often denied traditional credit, to obtain a mortgage and purchase a home.” This system has been successful, and has aided in promoting home ownership. However, the FHA loan program and its related benefits are under threat as the Department of Justice continues to bring investigations and actions against lenders under the False Claims Act.
Criticism of the DOJ’s approach is that the department is using the threat of treble damages available under the False Claims Act to intimidate lenders into paying outsized settlements and having lenders admit guilt simply to avoid the threat of the enormous liability and the cost of a prolonged defense. If the DOJ wanted to go after bad actors who are truly defrauding the government with dishonest underwriting practices or nonexistent quality control procedures, then that would be acceptable to the industry.
But the DOJ seems to be simply going after deep pockets, where the intentions of the lenders are well-placed and the errors found are legitimate mistakes. Case in point: as of December 2015, Quicken Loans was the largest originator of FHA loans in the country, and they are currently facing the threat of a False Claims Act violation. To date Quicken has vowed to continue to fight, and stated they will expose the truth about the DOJ’s egregious attempts to coerce these unjust “settlements.”
When an originator participates in the FHA program, they are operating under the Housing and Urban Development’s FHA guidelines. As HUD cannot, and does not, check each and every loan guaranteed by FHA to confirm unflawed origination, the agency requires certification that the lender originating the file did so in compliance with the applicable guidelines. If the loan defaults, the lender submits a claim and the FHA will pay out the balance of the loan under the guarantee.
The False Claims Act provides that any person who presents a false claim or makes a false record or statement material to a false claim, “is liable to the United States Government for a civil penalty of not less than $5,500 and not more than $11,000…plus 3 times the amount of damages which the Government sustains because of the act.”
The DOJ argues that when a loan with known origination errors is certified by the lender to the FHA, with a subsequent claim submitted by the lender to the FHA after a default, the lender is in violation of the False Claims Act — because they knew or should have known the loan had defects when they submitted their certification, and yet still allowed the government to sustain a loss when the FHA paid out of the loan balance.
In the mortgage space the potential liability is astronomical because of the aforementioned penalties. The major issues in a False Claims Act violation can be boiled down to two major points: lack of clarity and specificity around what the DOJ considers “errors;” and what constitutes knowing loans were defective under the DOJ’s application of the act.
To the first point: are the errors of the innocuous, ever-present type found in a large lender’s portfolio, or egregious underwriting errors knowingly committed to increase production while offsetting risk through the FHA program? Obviously, lenders are arguing the former.
Prior to Justice’s aggressive pursuit of these settlements, if the FHA identified an underwriting error the lender would simply indemnify the FHA and not process the claim, effectively making it a lender-owned loan. This was an acceptable risk to lenders, as an error in the origination process could not become such an oversized loss. The liability would be capped to any difference between the borrower’s total debt at the time of foreclosure sale and what the lender could recoup when the property was liquidated. The DOJ’s use of the False Claims Act now triples a lender’s risk when originating FHA loans by threatening damages that are triple the value of the amount paid out by FHA.
In his letter to all JPMorgan Chase & Co. shareholders in April, Chief Executive Officer Jamie Dimon outlined the bank’s reasons for discontinuing its involvement with FHA loans. This perfectly illustrates how the DOJ is basically restoring all the lender risk to FHA-backed originations. Banks originating FHA loans are left with two choices: price in the new risk of underwriting errors into and pass the cost to the end borrower, making the product so costly it becomes pointless to offer; or cease or severely limit FHA offerings. If lenders take either approach, the DOJ will have negated the purpose of the FHA by limiting borrowers’ access to credit.
Walking away from FHA lending is not as simple as it sounds. Most FHA borrowers tend to have lower credit scores and/or require lower down payments. Most FHA loans also tend to be for homes located in low- and moderate-income neighborhoods. Any decline in an institution’s FHA offerings most likely will have a negative impact on an institution’s Community Reinvestment Act ratings. One has to think the DOJ is well aware of this fact and believes it will keep lenders in the FHA business even with the elevated risk, and can simply continue to strong-arm lenders into settlements.
If the Justice Department continues to aggressively utilize the False Claims Act, originators will be forced to evolve and create a product that they can keep as a portfolio loan or sell privately that can reach the same borrowers the FHA-insured products currently do. Again, there is a high likelihood that these products will not have as attractive terms as the FHA loans that borrowers are currently enjoying.
Large lenders will continue to step away from FHA originations, and smaller lenders originating FHA loans should be strongly aware of the risk they are taking on by continuing to originate FHA loans and increasing their portfolios as the larger banks exit the FHA market. Many large lenders have faced or are currently facing these actions, and from the Justice Department’s recent statements it does not appear they will abate anytime soon.
The Administration has long shown it has a hearty appetite for the mortgage giants’ revenues. The two companies have already sent a combined $241.3 billion to the government since being placed in conservatorship 2008 – over $50 billion more than the $187.5 billion in taxpayer funds they received at that time. Should the “temporary” conservatorship and Third Amendment Sweep remain in force for at least another ten years the White House estimates the GSEs will send another $151.5 billion to the U.S. Treasury. That could mean these privately-owned mortgage giants will have sent nearly an astounding $400 billion to Treasury while needed reforms were put on hold.
The revenue projections in the budget proposal justify assumptions about why the Administration has had much less of an appetite for recommending ways to reform and recapitalize Fannie and Freddie and ensure they could provide liquidity and stability in the mortgage market for years to come. Why sell a cash cow? The Administration effectively yielded its statutory authority – and obligation – to end the conservatorship with the enactment of a massive spending bill late last year that included provisions of the so-called “Jumpstart GSE Reform.” Despite the bill’s name, it put Congress in the driver’s seat and all but guaranteed no additional action will be taken to end the conservatorship this year or perhaps not until well in 2017.
The proposed fiscal 2017 budget, like all blueprints before it, makes no room for the inevitable recession and market correction. Should a downturn occur in the next year or so, taxpayers will be obligated to provide additional bailout funding because Fannie Mae and Freddie Mac have been prohibited from building up adequate capital levels.
In a nod to the persistent problem of access to affordable housing, the budget proposal estimates Fannie and Freddie will provide another $136 million to the Affordable Housing Trust Fund in 2017. This money is provided to states to finance affordable housing options for the poor. The Administration reports this would be added to the $170 million set to be distributed this year. But here’s the catch: those funds derive from a small fee on loans Fannie Mae and Freddie Mac help finance but only as so long as they don’t require another infusion of public money.
In essence, President Obama’s final budget proposal counts money to which it was never entitled; it flaunts a disregard for the Housing and Economic Recovery Act’s requirement that Fannie Mae and Freddie Mac be made sound and solvent; and it takes a cavalier stance to the fact that under capitalized GSEs could have negative consequences for taxpayers and working Americans striving for home ownership. After eight years, the Administration’s parting message is that needed reforms in housing finance policy will simply have to wait for another president and another Congress. There is not urgency of now, just the audacity of nope.