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 • • • • • 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 . 2 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 nonsafe 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. 3 Credit Scores on Completed Transactions Still Well Above Normal Average FICO score – FHA endorsements 720 710 In addition: • Fannie Mae Weighted Average FICO on Acquisitions (Q3 2012): 761 700 690 680 670 • Freddie Mac Weighted Average FICO on Acquisitions (Q3 2012): 762 660 650 640 630 • Last Sequoia Deal: 771 620 Purchase Average FICO Score (Oct) Refi Average FICO Score (Jan) Sources: FHA Monthly, Fannie Mae and Freddie Mac Credit Supplements, S&P 4 Credit Pricing vs. Underwriting 5 Source: Fannie Mae LLPA Matrix Homebuyers Predominantly Served by Government Housing Programs 6 2011 HMDA Data – Purchase Originations 7 Source: FFIEC, MBA NOTE: Retail/Broker Originations for Home Purchase and Refinance – Secured by A First Lien Only, No Multifamily, 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 8 9 Retail Apps per Underwriter per Month 250 Large Lenders 200 Small Lenders 188 193 165 152 150 134 126 124 113 112 124 120 100 102 99 103 94 75 60 82 72 50 57 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 10 Source: MBA/STRATMOR Peer Group Survey 2011Data Show Net Exit from Business Number of Institutions Reporting HMDA Data 9,000 8,500 8,000 7,500 7,000 6,500 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: FFIEC 11 Basel III Overview Main Issues • • • • Increased capital requirements Increased risk weights Treatment of MI Treatment of mortgage servicing rights 12 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% 13 Basel III Impact on Mortgages Held in Portfolio Funding examples for 95 LTV mortgage with MI: Category 1 Mortgage Mortgage Funded with Deposits Equity Category 2 Mortgage $ 100 $ $ 96 4 Total cost Mortgage Cost 2% 15% 2.52% Under Basel III: Funded with Deposits Equity $ $ Funded with Deposits Equity $ 100 $ $ 96 4 Total cost Cost 2% 15% 2.52% Under Basel III: 92 8 Total cost Cost 2% 15% 3.04% Increase: 0.52% Funded with Deposits Equity $ $ 84 16 Total cost Cost 2% 15% 4.08% Increase: 1.56% 14 Impact of Basel III on Mortgage Servicing Rights Basel 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. 15 Impact of Basel III on Banks with MSRs Under Current Rules Assets Cash Residential mortgages Consumer loans Commercial loans Mortgage servicing rights Other assets Total assets $ 15,000 $ 200,000 $ 50,000 $ 100,000 $ 15,000 $ 10,000 $ 390,000 Liabilities Deposits Other Liabilities $ 345,000 $ 5,000 Equity $ Risk Weights 0% 50% 100% 100% 100% 100% $ 345,000 $ 5,000 40,000 $ (11,000) $ Tier 1 capital: $ 40,000 Risk-weighted assets: $ 275,000 Risk-based capital ratio: Under Basel III Deductions Risk from Equity Weights $ 15,000 0% $ 200,000 100% $ 50,000 100% $ 100,000 100% $ (11,000) $ 4,000 250% $ 10,000 100% $ 379,000 14.5% 29,000 Tier 1 capital: $ 29,000 Risk-weighted assets: $ 370,000 Risk-based capital ratio: 7.8% 16 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. 17 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. 18