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Secondary market.


Today's environment for mortgage lending represents many challenges for the secondary market agencies. The challenges faced by agencies and companies are an outgrowth of at least four major events or trends. It is expected that these four factors will have a strong influence on mortgage banking activity during the early 1990s, and perhaps beyond.

So what are these four factors?

The first factor is the threat of a legislative requirement that Fannie Mae and Freddie Mac achieve a triple-A corporate debt rating within five years. The mere threat of such a requirement has caused a noticeable change in the way these agencies view risks. This has been evident in the limited multifamily rental property financing done by both agencies. Most recently, Freddie Mac's termination of its multifamily cash program is a clear example of the agency's willingness to make sudden and dramatic changes in corporate policies to protect their capital position. Of course these decisions might have eventually been made even if there was no threat of a triple-A requirement. But there's little doubt that the agencies' tolerance for losses and risks have been diminished as a result of the triple-A threat.

Legislatively speaking, it does not appear that such a requirement will be enacted. Instead, the worst we can expect now is that Congress will require a report by Treasury on the financial soundness of government-sponsored enterprises (GSEs) and a report by the Congressional Budget Office (CBO) on the types of risks assumed by each GSE. Treasury would also be required to report proposed legislation on GSE financial soundness. Whether or not the triple-A standard becomes a reality, the agencies can ill-afford to be in a position where such a rating is out of reach. The triple-A threat imposes a private market discipline on these agencies that will require some sacrifice of public purpose objectives. It is expected that the triple-A factor will force the agencies to improve asset quality. To do this, the agencies are likely to focus on underwriting, quality control programs of seller/servicers and the quality of their customer base.

The second factor is the forthcoming FHA legislation adopting a risk-based premium concept and increased insurance premiums and down payment requirements paid by borrowers. Some view this as the beginning of the end for FHA because the law would make the FHA program less attractive to prospective borrowers vis a vis private insurance programs. The VA program also has been hurt by the risk of loss associated with VA no-bids. The expected reduced volume of FHA/VA loans will mean a reduction in future GNMA securities issuance volume. If a dramatic shift from government loans to conventional loans occurs, then the very reason to exist for FHA/VA/GNMA programs will eventually be called into question.

The third factor is the capital treatment of purchased mortgage servicing rights and mortgage asset sales with recourse. With respect to PMSR, it now appears that more liberal treatment than the 25 percent of tier 1 (or core capital) is likely. The FDIC has stated that the limit they will adopt will be "marginally higher than the 25 percent limit." We believe that there is a good chance that the limit will be increased to 50 percent. The OCC, in a notice of advanced rulemaking, is requesting comment on its current 25 percent limitation. The fact that the OCC is requesting comment on a rule that does not have to be changed suggests that the OCC believes the current limitation to be inappropriate. On the subject of recourse, the Federal Financial Institutions Examination Council (FFIEC) is not expected to make a decision on whether or not certain mortgage asset sales with recourse and VA loans in GNMA pools constitute "financings" and consequently, require additional reserves of bank capital. The outcome of these rules will have an impact on how mortgages are originated. To the extent that the ability to purchase servicing is limited through capital constraints we may see greater emphasis on self-originations. Moreover, the cost of the regulatory capital constraints will be reflected in reduced servicing released premiums paid to originators. Many originators will find it difficult to survive on these smaller fees so some further industry consolidation at this level is probable. A limited ability to do recourse transactions means two things: reduced underwriting flexibility and reduced profits for those institutions who were adept at managing this kind of risk.

The fourth and final major influencing factor is the economy. Even before Iraq's invasion of Kuwait, the demographics did not favor housing finance. With the invasion and a budget impasse, we are faced with the prospect of prolonged higher interest rates, oil price-induced inflation, recession and weak demand for homeownership. Real estate prices have been falling in many places that were considered "boom" areas just a couple of years ago. The economy will influence the decision-making calculus of the secondary market agencies because it is the type of environment that produces more deliquencies, foreclosures and REO losses. To position themselves to avoid losses and stay within reach of a triple-A rating, the agencies will be tightening credit. The first target was the multifamily loans. The next targets will be low doc loans, and high LTV ARMs and lender eligibility.

In times past, the secondary market agencies were able to supply credit in both bad and good economic times. They were able to do this because they did not have to adhere to a strict private market discipline while attempting to carry out their public missions. It appears that the administration and some members of Congress are unwilling to risk even the most remote possibility of taxpayer bailout in order to maintain a steady flow of mortgage credit. The real challenge of the secondary market agencies is to respond to this difficult environment in a way that does not disrupt the mortgage delivery system.
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Title Annotation:factors influencing the secondary mortgage market
Author:Taliefero, Michael
Publication:Mortgage Banking
Article Type:column
Date:Nov 1, 1990
Previous Article:The Random Character of Interest Rates.
Next Article:Economic trends.

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