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The Future of Mortgage Finance: QM, QRM and Basel III Jay Brinkmann* Chief Economist and SVP , Research & Education. *Comments and opinions are solely those of the presenter and do not necessarily represent official positions of the MBA or its members. Components of Mortgage Finance Industry. - PowerPoint PPT Presentation
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The Future of Mortgage Finance:QM, QRM and Basel III
Jay Brinkmann*Chief Economist and
SVP, Research & Education
*Comments and opinions are solely those of the presenter and do not necessarily represent official positions of the MBA or its members.
2
Components of Mortgage Finance Industry
• Borrowers• Originators/Loan Officers• Institutions, charter-type and size• Secondary market execution versus portfolio• Servicing
Each is being impacted in a major way, but by far more than just QM, QRM and Basel III .
3
Borrowers
• Credit tightened because big increases in loss severity make any defaults very expensive.
• Current and future drivers of severity• Liability under ability to repay provisions of QM for non-
safe harbor loans. Legal costs plus potential legal damages.
• Defaulted loan servicing costs under new guidelines.• Greatly increased foreclosure timelines in some states.• Pattern of buy-back demands from GSEs and other
investors.
Due to 150 bp over APR limit on risk-based pricing, few high risk loans will be made to avoid going above the QM safe harbor trigger.
4
Credit Scores on Completed Transactions Still Well Above Normal
January
-07
April-07
July-07
October-
07
January
-08
April-08
July-08
October-
08
January
-09
April-09
July-09
October-
09
January
-10
April-10
July-10
October-
10
January
-11
April-11
July-11
October-
11
January
-12
April-12
July-12
October-
12620
630
640
650
660
670
680
690
700
710
720
Average FICO score – FHA endorsements
Purchase Average FICO Score (Oct) Refi Average FICO Score (Jan)
In addition:
• Fannie Mae Weighted Average FICO on Acquisitions (Q3 2012): 761
• Freddie Mac Weighted Average FICO on Acquisitions (Q3 2012): 762
• Last Sequoia Deal: 771
Sources: FHA Monthly, Fannie Mae and Freddie Mac Credit Supplements, S&P
5
Credit Pricing vs. Underwriting
Source: Fannie Mae LLPA Matrix
6
Homebuyers Predominantly Served by Government Housing Programs
7
2011 HMDA Data – Purchase Originations
Source: FFIEC, MBA NOTE: Retail/Broker Originations for Home Purchase and Refinance – Secured by A First Lien Only, No Multifamily,
8
Challenges for Institutions
• Higher operating costs driving out smaller lenders and reducing economies of scale for larger lenders
• Effectiveness of different business models in a market dominated by purchase mortgages
• Regulatory and liability risks to bank business caused by mortgage business
• Reputation risks from disparate impact claims and other discrimination allegations
• Basel III
9
10
Retail Apps per Underwriter per Month
188
152
134
165
126
103
124 113
75
60
193
120
102
124
99
112
82 94
72
57
0
50
100
150
200
250
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Large Lenders Small Lenders
Source: MBA/STRATMOR Peer Group Survey
11
2011Data Show Net Exit from Business
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20116,500
7,000
7,500
8,000
8,500
9,000
9,500
Number of Institutions Reporting HMDA Data
Source: FFIEC
12
Basel III Overview
Main Issues
• Increased capital requirements• Increased risk weights• Treatment of MI• Treatment of mortgage servicing rights
13
Basel III Risk Weights for Residential Mortgages
LTV Category 1 Category 2(QM?) (non-QM?)
60 % or less 35% 100%
80% to 60% 50% 100%
80% to 80% 75% 150%
Greater than 90% 100% 200%
14
Basel III Impact on Mortgages Held in PortfolioFunding examples for 95 LTV mortgage with MI:
Category 1 Mortgage Category 2 Mortgage
Mortgage 100$ Mortgage 100$
Funded with Cost Funded with CostDeposits 96$ 2% Deposits 96$ 2%Equity 4$ 15% Equity 4$ 15%
Total cost 2.52% Total cost 2.52%
Under Basel III: Under Basel III:
Funded with Cost Funded with CostDeposits 92$ 2% Deposits 84$ 2%Equity 8$ 15% Equity 16$ 15%
Total cost 3.04% Total cost 4.08%
Increase: 0.52% Increase: 1.56%
15
Impact of Basel III on Mortgage Servicing RightsBasel III will make it very expensive for banks to hold mortgage servicing rights:
• MSRs more than 10% of Tier 1 capital must be deducted from equity. Given fluctuations in MSR values due to interest rates, the size of this deduction is unknown from quarter to quarter.
• Remaining MSRs carry a 250% risk weight.• MSRs plus most deferred tax items are limited to 15% of
Tier 1 capital.
16
Impact of Basel III on Banks with MSRs
AssetsRisk
Weights Deductions from Equity
Risk Weights
Cash 15,000$ 0% 15,000$ 0%Residential mortgages 200,000$ 50% 200,000$ 100%Consumer loans 50,000$ 100% 50,000$ 100%Commercial loans 100,000$ 100% 100,000$ 100%Mortgage servicing rights 15,000$ 100% (11,000)$ 4,000$ 250%Other assets 10,000$ 100% 10,000$ 100%
Total assets 390,000$ 379,000$
LiabilitiesDeposits 345,000$ 345,000$ Other Liabilities 5,000$ 5,000$
Equity 40,000$ (11,000)$ 29,000$
Tier 1 capital: 40,000$ Tier 1 capital: 29,000$ Risk-weighted assets: 275,000$ Risk-weighted assets: 370,000$
Risk-based capital ratio: 14.5% Risk-based capital ratio: 7.8%
Under Basel IIIUnder Current Rules
17
QRM/Risk Retention
• QM is designed to protect borrowers, QRM is designed to protect investors.
• The retained risk requirements are still to be determined but will be based on the investors (Fannie, Freddie and FHA loans are exempt) and the credit risk of the loans.
• Strong industry push to make QM and QRM guidelines the same.
• The big problem with QRM is that investors set the credit criteria and originators will have to hold capital against risk models and risk appetites they do not control.
• The result will be a further narrowing of credit and significant impediment to the resumption of a private label market for mortgage-backed securities.
18
Conclusions• Increasing operational and compliance complexity favor big
banks, BUT• Smaller independents have been better at originating purchase
mortgages, BUT• The regulatory complexities and potential QM liabilities and
increased GSE &FHA fees point toward putting more loans into portfolio, BUT
• The increased Basel III capital requirements (and interest rate risk of long-term, fixed rate mortgages) make that expensive, BUT
• Basel III requirements on MSRs and potential QRM retained risk requirements make securitization a problem, BUT
• The Justice Department and HUD will sue you if you don’t make the loan.