Category: Housing

What is QRM?

Posted by admin Apr 19, 2011 No Comments »

QRM are “Qualified Residential Mortgages” as defined in Dodd-Frank Act. They are special mortgages that are exempt from “skin-in-the-game” requirements, i.e. securitizers don’t have to retain risk of at least 5% when selling mortgage bonds backed by these “low risk” mortgages.

You can review below QRM specifications and their implications.
QRM And Its Implications

There is quite a bit of discussion going on in Capitol Hill and Wall Street, among others, on what are the implications of these specifications on market participants, borrowers, and government housing goals.

No matter how broadly or narrowly QRM is defined, I believe that the overall cost of mortgages will go up in future so we better be ready for the change.

Future of the Housing Market: White Paper by Tim Geithner

Posted by admin Mar 10, 2011 No Comments »

There is a major overhaul currently underway in the structure of our housing market, including both the primary market (see here) and secondary market (see here).

Dodd-Frank Wall Street Reform and Consumer Protection Act laid out the vision for future by creating a new paradigm that controlled by rampant abuse of housing practices by all parties involved. Subsequently, white paper “REFORMING AMERICA’S HOUSING FINANCE MARKET” released by Treasury Secretary Timothy Geithner has spelled out in more detail what the reforms would look like.

The white paper is just a proposal and would be debated next year or two before its recommendations would be converted into laws and fully implemented.

Some of the highlights of that white paper are:

1) GSE Reform: Government Sponsored Entities, such as Freddie and Fannie would be wound-down in next 5 to 7 years. They are blamed for conflicting missions (housing goals and profit making) and skewed operating structure (public risk, private rewards).

2) Retained Portfolio of GSEs: GSEs portfolio of whole loans and MBS would be reduced so as to reduce the risk to taxpayers who are on the hook for losses on those assets. Loan limits that are eligible for GSE purchases would also be decreased.

3) GFee of GSEs: In order to shore up GSE balance sheet and prevent losses going to taxpayers, Guarantee Fee (or GFee) needs to be raised. Additional charges and fees may also be necessary. They also need to hold more Capital to back their liabilities, thus requiring additional compensation from originators.

4) FHA Reform: Role of HUD owned Federal Housing Agency (FHA) need to be limited. Currently FHA is taking too big of a role in the housing market putting too much risk on the Government. Its mission for supporting low-to-moderate income borrowers will remain intact and further enhanced.

5) Role of Private Capital: Government wants to bring in more private capital to take on default risk and credit losses associated with mortgage loans. The above measures as well as requirements for additional private credit enhancement, down payments by borrowers, and risk retention by Banks on securitized loans would be implemented.

6) Rental Support: More Government resources to make rental an attractive option vis-à-vis owning a home, especially for low-to-moderate income families.

7) Qualified Residential Mortgage (QRM): These are high quality loans with enough private capital backing that they would be exempt from “risk retention rule”. This rule requires Banks to retain at least 5% of the risk on their books for securitized loans. This is also called skin-in-the-game rule. Faulty practices of originating risky loans and then selling them off without any consequences are cited as a major cause of the housing crisis. This rule tries to prevent similar situation from arising the future.

On top of the above recommendations, the paper also listed 3 major options to choose from to decide what role Government should play and when it should play. These options are

1) Option 1: Government is restricted in its role to only helping low-to-moderate income families. Private Capital is the main driving force in the housing market.

2) Option 2: Government role essentially the same as Option 1 but the role scaled up to help with liquidity and losses in times of housing crises.

3) Option 3: Government role same as Option 1 plus providing back stop to remote risk of loan losses. Private Capital essentially takes most of the losses in most of the situations.

The proposal has just been tabled in the Congress. I still expect long road ahead before these recommendations will become laws and implemented. These are certainly exciting times in the housing market.

Current Structure: Secondary Mortgage Market

Posted by admin Jan 05, 2011 3 Comments »

Secondary Mortgage Market

The space where mortgages are bought and sold after they have been originated (buyer has bought the house and mortgage placed on it) is called Secondary Mortgage Market. It is secondary because the buyer is not affected and the interactions are between two unrelated parties to the original (or primary) transaction.

Why does Secondary Mortgage Market Exist?
The main reason is that Banks, especially the Mortgage Banks, are in the business of originating loans to borrowers and making money doing that. They want to originate more loans to as many buyers as possible and need funds for that. They could either way 10-15 years to get their funds back from the borrowers or sell the loans in Secondary Mortgage Market to get funds much more quickly and passing on the long-term returns (after skimming some from the top to compensate for their efforts) to appropriate investors who are willing to wait to get their principal investment back.

Some of the most common ways mortgages are bought and sold, and steps involved are:

1) Lender/Bank has originated the mortgage. It has the loan associated with the mortgage on its “books” – the loan is an asset on Bank’s Balance Sheet.

2) Lender either keeps that “whole” loan (mortgage goes with the loan) or sells it as a whole loan (ownership to all the future cash flows repaid by the borrower) to another Bank who would like to get that return built into the loan.

3) Another option is for the Bank to convert that loan into an MBS – Mortgage Backed Security. The loan is not “whole” anymore and the cash flows of several loans are pooled together into a Trust. These funds are then distributed to the investors who buy ownership in the Trust by buying bonds called MBS. This entitles them to some share of the cash flows generated by loans in the Trust.

4) There are three main paths taken to create MBSs
a. Agency/GSE MBS: GSEs are Government Sponsored Entities such as Fannie Mae and Freddie Mac. Now they are really GEs – Government Entities since they are in conservatorship of the Government Regulator. High risk loans (such as high LTV, Loan-to-Value) require some kind of credit enhancement before being placed into GSE MBSs. The Banks either sell their loans to GSEs, who guarantee the timely payment of Principal and Interest (P&I) and charge a fee for it, who in turn create “Agency MBS” and sell them to large investors or they “convert” the whole loans into Agency MBS buy simultaneously selling whole loans and then immediately buying MBS from GSEs for their portfolio.

b. Government/Ginnie MBS: Ginnie Mae is completely owned by the US Government and it buys loans from Banks that are credit protected by other Government entities such as FHA/VA. FHA has started playing a bigger and bigger role in the housing market ever since the collapse of the housing market as its rates and underwriting guidelines continued to be the same as before the crisis. So as others cut back on their business, more business flowed into FHA. As the loans are essentially backed by US Government, the default risk on the loans is completely eliminated for the investors.

c. Private Label MBS: These are high risk loans that are not backed by FHA/VA and not eligible to be bought or guaranteed by GSEs. Banks originate these higher return loans and package them themselves using some legal structures into various types of bonds (Private Label MBS). These bonds carry default risk in additional to normal interest rate risk to the investors. Investors therefore demand higher returns to invest in these types of securities. If the economics work out then these types of bonds are created and sold by Banks to willing investors to replenish their funds and make more loans to more buyers.

You can see the interaction of different parties in the graphic below:

Current Structure: Primary Mortgage Market

Posted by admin Dec 14, 2010 No Comments »

Housing market or more specifically mortgage market has two distinct sections that are sometimes thinly connected. The recent crisis about blighted titles on mortgages and missing paper trail of legitimate claims on a properties, which lead to several big lenders halting their foreclosure proceeding, attest of that thin connection. The two distinct pieces of the mortgage market are usually known as

1) Primary Mortgage Market, and
2) Secondary Mortgage Market

The primary mortgage market is primarily concerned with originating a loan and involves interaction between borrower and lender. Secondary mortgage market is the arena where loans that have been originated already get traded like an asset or a security. This happens after the fact and does not affect the borrower/homebuyer in any material way, until, maybe when default occurs.

Lets look at two sections of the mortgage market one by one, starting with primary mortgage market. The link below shows different participants and various steps they are involved in or go through and make up primary mortgage market.

Primary Mortgage Market

Different steps that a borrower sees in the primary morgage market are as follows:

1. A person is looking for a house to buy. He is now considered a homebuyer.

2. He gets in touch with a real estate agent who helps him in finding the appropriate house. A lot of homebuyers skip this step and search for the house themselves.

3. Homebuyer finds the house that he likes and wishes to buy. He usually doesn’t have the cash required to close the deal. So, he is in urgent need of funds.

4. He gets in touch with a mortgage agent from whom he can get the funds. There are various ways and resources available to him, including his present or local Bank, which he can utilize. He fills out a loan application detailing his financial situation to the lender with the intent of proving his ability to repay the loan.

5. Lender or the Bank reviews the application. This process is called “underwriting the loan”. Bank verifies borrower’s financial details such as assets, liabilities, cash flows, credit history etc as well as details about the property in question.

6. If the Bank makes a judgement that the borrower has good ability to repay the loan and property can serve as a good collateral then loan application is approved.

7. Bank lends the money. The borrower sees this money at the time of closing on the house. Funds are distributed to the parties involved. Borrower makes a promise to repay the loan in a legal document (promissory note), and lenders uses property as a collateral against the loan (mortgage).

8. A mortgage is born. The Bank may keep the mortgage or sell it later (just like an asset) to someone else in what is called a secondary mortgage market. Banks usually fork out the job of collecting monthly payments from the borrower to another company, called the servicing company. Although some of the big mortgage banks service their own mortgages and do not utilize an outsourcing company.

From this point onwards, borrower is not really concerned about which company is holding his mortgage. All he cares about is knowing where to send the monthly mortgage payments and whom can he approach to get on-going support and help in making those payments.

Future of Housing Finance: Introduction

Posted by admin Oct 06, 2010 No Comments »

Congressional Hearings Shed Light on Possible Future of Housing Finance

Congress recently called different participants in the housing market to provide their feedback and inputs on housing finance. The discussion was mainly focused on what participants’ view was on what housing finance may look like in future, and what role, if any, should government play in the marketplace.

Participants included securitization industry groups, secondary market investors, academicians, and housing professionals. Their testimonies provided great insight into where the weaknesses lie in the current system, what is working just fine, and what needs to change.

Before figuring out what the future of the housing market might look like, it would be a good idea to spend some time understanding the present structure – participants, flow, and inter-relationships. This will not only provide us with a good foundation to understand the discussion but also give us an idea of the weaknesses of the system.

In the first part of my series on housing finance, I will cover the current system of housing market.