Without a doubt, one the biggest challenges the credit industry faces is to return private capital to the mortgage market. On the heels of the publication of the CFPB (Consumer Financial Protection Bureau) Qualified Mortgage Rule, and just ahead of ASF 2013, the largest capital-markets conference in the world, The Score caught up with secondary market expert Tom Donatacci, Executive Vice President of Sales and Marketing at Clayton Holdings. Headquartered in Shelton, Connecticut, Clayton provides information and services that financial institutions, investors and government entities use to evaluate, acquire, securitize, service and monitor loans and asset-backed securities.
The recent publication of the QM rule has been an important step in bringing private capital back into the RMBS market, but may bring with it more questions than answers. One of the biggest issues the mortgage industry has faced over the past few years is uncertainty. With QM in place, the mortgage industry and investors have a much better understanding of the type and quality of loans that will be on the market come January 2014, when the rule takes effect.
The problem, today and potentially in the future, may be the amount of available product to securitize. With a maximum DTI [debt-to-income ratio] of 43% and a 3% cap on fees and points, QM could act to artificially constrain lending in instances where credit standards might otherwise be loosening naturally. Additionally, the 3% cap on points and fees includes not only broker compensation and potentially loan officer compensation, but affiliate fees as well. This could discourage lenders from using their own title or appraisal companies, putting in jeopardy what could be a potential savings to the borrower. The positives are that Qualified Mortgages will be under a safe harbor from litigation surrounding a borrower’s ability to pay, and will still have rebuttable presumption if a borrower’s APR is more than 150 bps [basis points] over the Average Prime Offer Rate. GSE-eligible loans will have the 43% DTI limit waived, but inconsequential in increasing the number of private-label securities.
An additional concern is the high level of assignee liability for loans that are subject to, but do not meet, the repayment ability standards; which include triple the finance charges paid, plus costs and attorneys fees. So while Safe Harbor loans should be seen as safe to securitize, it is still questionable whether loans that are subject to a rebuttable presumption or loans that are not QRM will be securitized.
The component of the rule, QRM, will bring with it the definition of which loans will require lender risk retention, and which will be exempt. While the definition is another important step in finding clarity in an evolving industry, it has the potential to require minimum down payments which could further reduce the number of borrowers who fit the criteria of these rules.
The finalization of QM and QRM will allow lenders to start the flow of non-agency origination with loans that meet the new requirements. However, lenders will have to demonstrate that they have fully implemented policies and procedures that ensure the loans will be interpreted the same way by the agencies as they are by the bank. While protections afforded with these rules may help with an initial increase in securitizations in 2014, the rules that the industry has been so anxiously anticipating may not open up mortgage availability as much as expected, or was hoped for.
There have been a number of observable changes in the rating agencies’ systems and processes, and I am sure that substantial changes not visible from outside the agency have also occurred. Most notably, the incorporation of independent due diligence results into the agencies’ ratings process is a significant improvement, from our perspective. The ratings agencies are using the due diligence results to determine whether the mortgage loans were originated in compliance with applicable underwriting standards and regulatory compliance legislation. Indeed, we share the view of others in the industry who posit that expanded due diligence and access to file review results might warrant revising modeling assumptions, adjusting enhancement levels and/or changing ratings.
Undoubtedly, the ratings agencies are pressing for transparency at a granular level on each and every loan underpinning all new issuances. As part of the new process, there is a Conditions Report furnished by the diligence firms that specifies potential issues from a credit, property valuation and regulatory compliance standpoint. The report clearly outlines what was initially uncovered in due diligence and what ultimately transpired to bring each issue to resolution. The ratings agencies scrutinize this report and ask for clarification from the issuer and diligence firm when necessary.
Additionally, the ratings agencies indicate that they now tie the due diligence review to the strength of the reps and warrants provided on a transaction and to the originator’s performance history relating to previously securitized assets.
These are just a couple of highlights to what has been an iterative process. Rating agencies are reviewing and updating their criteria as deals are done and their experience in the new world of securitization grows, while regularly educating the market along the way.
Currently, the GSEs [government-sponsored enterprises, e.g. Fannie Mae and Freddie Mac] and FHA [Federal Housing Administration] are backing more than 90% of all origination activity and, in effect, crowding private capital out of the housing-finance picture. Historically, these agencies only bought and guaranteed loans with much lower values. What we proposed was simply going back to where the market had been before the mortgage crisis, and letting the private market resume its historical role. This will be key to restarting non-agency securitizations.
Gradually decreasing loan levels, a process that has already begun with the GSEs, will enable banks and investors to participate more broadly in the prime jumbo market, and send a clear message to the market that the Administration is serious about its stated goal of reducing the government’s role in the mortgage business.
Recent legislation and agreements including the development of national servicing standards, the AG [U.S. Attorney General] Settlement, OCC [Office of the Comptroller of the Currency] requirements, and impending CFPB examinations have all descended on servicers simultaneously. Staying on top of the myriad of requirements that have been hitting the industry has proven difficult for servicers, especially as they wait for final rules to be published, and in some cases, wrestle with how the rules work in relation to each other.
We’ve seen human capital challenges—especially given the tightened definitional role of the Single Point of Contact. Many firms are facing a staffing issue in that they must recruit and retain client-focused representatives who must also be fully versed in every step of default servicing, from loss-mitigation through foreclosure. Ideal candidates with sufficient experience and the right skill set to carry the role can be hard to find, but it is a required mandate. In addition, many firms have had to address issues that simply weren’t considerations before, such as the development of borrower portals, which can be a costly endeavor.
Addressing these new regulations can be a challenge for many servicers and the subservicing market has revived as a result. This has created opportunities for third-party servicers with regulatory compliance being a key driver.
As one might expect, credit evaluation has moved to increased levels of scrutiny, disclosure and transparency. The days of stated-income or no-documentation loans are long behind us, and the pendulum has swung, requiring unparalleled levels of analysis on tax returns and other income documentation.
An increase in document scrutiny was an expected outcome from the recent history of the mortgage market, but a shift has also occurred in the way that we look at a borrower. While guidelines give a good picture as to whether or not a loan has been underwritten properly, we additionally employ a layered-risk approach in looking at a borrower’s past, present and future ability to repay a loan. This information is supplemented by more extensive commentary, which has moved away from standardization and allows reviewers to use their expertise to craft notes specific to each borrower’s situation and giving color to clients that haven’t traditionally been found in a credit review. We’ve also enhanced commentary surrounding our extensive exception-management system. When clearing conditions associated with a file, the due diligence team is providing more than just compensating factors, including the detail as to why these factors allow us to feel comfortable with the decision.
Our systems have evolved as well, with features such as enhanced data verification and the capture of both initial and final grading. Even if a loan isn’t headed for securitization, we’ve increased levels of data and transparency to allow our clients to identify both individual and systemic problems associated with a seller’s loans.
Credit evaluation has become an evolving process that is responsive not only to client requests, but anticipates the need for increased levels of disclosure to always give clients the most complete view of a loan as possible. Understanding credit risk has become both a science and an art, requiring airtight systems and processes supplemented with the case by case experience of a seasoned underwriting team. This isn’t your father’s due diligence process.