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
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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%
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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.
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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.
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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.
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