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The secondary market.

THE SECONDARY MARKET

Since its creation in 1946, the VA program epitomized how well the federal government works with the private sector to expand homeownership opportunities. Continuing in this tradition, Congress recently expanded these opportunities by increasing the VA loan limit to $184,000. This will help veterans to pursue the American dream of homeownership in high-cost real estate markets.

Unfortunately, the losses associated with VA no-bids have caused some within Ginnie Mae to question the design of the VA program. A VA no-bid occurs when the VA elects not to take possession of a foreclosed property. Instead, the VA pays the lender the VA guaranty amount and the lender must dispose of the property, frequently at a loss.

The industry is hopeful that Ginnie Mae will not limit the inclusion of loans in Ginnie Mae pools. Ginnie Mae officials are concerned, however, that VA loans carry a greater risk of loss than FHA loans. Ginnie Mae's fears are based in part on the way VA plans to increase no-bids. Reportedly the VA 1991 budget will contain a requirement that VA submit legislation to alter the no-bid formula. The proposal would require that VA's average loss per property be deducted from the net value at the time of foreclosure. The VA is currently losing an average of $7,200 per property that it takes back and sells. The VA estimates if this change to the formula is made, no-bids will increase to 48-50 percent of all foreclosures. They are currently 23 percent. Accordingly, Ginnie Mae has been considering for some time whether or not to create requirements that give Ginnie Mae more protection from risk of loss due to VA no-bids. The requirements that have been under consideration include: restricting the number of VA loans greater than $144,000 to be included in a single pool; requiring some down payment on those loans before they would be securitizable; or requiring the issuer to post some type of credit support (e.g., letter of credit) when pooling these loans.

The underlying assumption for Ginnie Mae requiring greater protection from risk of loss is that the higher balance loans create higher risks of loss for Ginnie Mae in the form of VA no-bids. In support of its position, Ginnie Mae cites the ever-increasing VA no-bid losses Ginnie Mae issuers issuers have been unable to absorb the VA no-bid losses that have been estimated to be approximately $20,000 per loan. Consequently, when an issuer defaults, Ginnie Mae assumes the role of the issuer and any losses the issuer would have had to absorb.

The MBA does not deny that lenders have incurred considerable and unexpected financial liability in connection with the VA program because of the no-bid process. In fact the MBA-formed VA task force to study the impact of VA no-bids found that the bulk of the no-bids occur on lower loan amounts. Higher loan amounts tend to be less risky.

A review of information collected from FY 1979-1988 on foreclosure liquidations for loan amounts ranging from below $30,000 to $130,000 and above substantiate this claim. (Source: Department of Veterans Affairs) The findings indicate that 75 percent of foreclosure liquidations occurred on loan amounts between $30,000 to $79,999. Even more revealing is the fact that less than 1 percent of foreclosure liquidations occurred on loan amounts $130,000 and above.

Furthermore, the statistics reveal that with the exception of California, no-bids are concentrated in economically distressed areas. The states with the highest numbers of no-bids in 1988 included: Texas, Colorado, Oklahoma, Alaska, California and Wyoming. (California's ranking in the top six is most likely a function of the large number of VA loans made in that state.) No-bids in these six states comprise 69 percent of the U.S. total in FY 1988. No-bids in these areas created severe problems for lenders with significant servicing portfolio concentration in these states. If one uses the MBA estimate that each no-bid results in a likely $20,000 loss, the 3,293 no-bids in Texas would result in a $66 million loss in FY 1988 representing 29 percent of the total estimated VA no-bids losses of $228 million. California, on the other hand, while representing 10 percent of the VA activity for the country (measured by total applications) would comprise less than 4.7 percent of total estimated VA losses. The regional pattern of the problem continued to be reinforced in FY 1989. Specifically, 16 issuer defaults occurred in FY 1989, 10 of which were Texas-based firms representing 31 percent of the total VA no-bid losses for the year.

As noted, the occurrence of a single no-bid for a lender can cost a company, on average, about $20,000. The problem is exacerbated when no-bids are concentrated in economically distressed areas. This suggests that economic factors, rather than loan amounts, play a greater role in explaining the high occurrence of no-bids and their attendant losses. For example, higher loan amounts are not generally originated in distressed areas. Instead a higher loan amount would tend to indicate a better quality home located in a stable neighborhood. Furthermore, these areas are likely to be characterized by a solid local economy accompanied by strong employment and increasing personal income. These are all positive factors pointing to a lower likelihood of foreclosure, the trigger for VA no-bids.

If Ginnie Mae decides to require down payments for VA loans above $144,000, this will probably do little to stem losses in economically distressed areas. Requiring VA loan-only pools would effectively create a new Ginnie Mae security with different prepayment expectations and pricing variations. Credit enhancements would be an unfair burden for issuers to shoulder. Nevertheless, Ginnie Mae's adoption of any one of these possible scenarios would send an important signal to VA administrators and Congress - that Ginnie Mae will not stand idly by and allow their reserves to be depleted by an unreasonable policy.

As the studies indicate, the no-bid problem is an isolated one and perhaps calls for a targeted solution. The implementation of an across-the-board policy does not serve the veteran or the lending community. The prescription calls for a narrowly defined approach. Ginnie Mae and VA could mitigate losses through the implementation and improvement of internal controls. It is well known that VA could have avoided foreclosure on many properties if it utilized workout procedures and assistance programs available to veterans. By improving its oversight of all of its issuers, custodians and subservicers through monitoring and analysis of financial position, Ginnie Mae could identify areas of potential risk and future loss and plan accordingly.

Regardless of Ginnie Mae's approach, at the most fundamental level, if the no-bid problem is ever going to be solved, it must be through quality underwriting. In an area of economic distress, borrower underwriting should be handled with extreme caution. The most important aspect of this involves the appraisal. A more reasonable approach is for the VA to implement a program that allows the lender to review the appraisal and assess the value of the Certificate of Reasonable Value (CRV) issued by the VA. This would give lenders additional control over the origination process. This is particularly important in light of the increase of VA no-bid losses in economically depressed areas. Many MBA members believe that the VA staff issues CRVs with appraised values much higher than is appropriate for a given market. Furthermore, members also maintain that the most liberal underwriting decisions are made by VA staff and not the lender. In cases where VA makes the underwriting decision, the no-bid option should not be allowed.
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Title Annotation:VA no-bids and Ginnie Mae
Author:Allen-Malzahn, Deborah
Publication:Mortgage Banking
Article Type:column
Date:Feb 1, 1990
Words:1269
Previous Article:Economic trends.
Next Article:HUD reform: the media event.
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