Analyst Rich Eckert on the Mortgage Landscape

Fannie’s Squeeze Makes 4% Mortgage Too Good to Be True

By Jody Shenn, Bloomberg

Government efforts to make lenders pay for soured mortgages may be keeping potential borrowers from record-low interest rates, slowing home sales and refinancing as banks tighten standards to avoid more demands for refunds.

Lenders are insisting on higher credit scores and more documents than required by the Federal Housing Administration and government-backed Fannie Mae and Freddie Mac. Quicken Loans Inc. and Vision Mortgage Capital are among firms saying they are increasing scrutiny of would-be borrowers in response to pressure to cover losses incurred on U.S.-backed housing debt.

“You’ve got to take measures now to protect yourself,” John B. Johnson, chief executive officer of Birmingham, Alabama- based MortgageAmerica Inc., said during a panel discussion this month. Demands that lenders repurchase bad mortgages from Fannie Mae and Freddie Mac are “casting a pall over the market. I fear that it will face a much longer recovery because of this.”

Mortgage rates as low as 3.94 percent are proving insufficient to revive housing. Sales of existing homes fell 3 percent last month, National Association of Realtors data show, and 18 percent of the group’s members reported contract cancellations, at least twice as high as in normal circumstances. Among the reasons were refusals of loan applications after appraisals came in below sales prices.

Faulty mortgage lending and foreclosure practices have cost the five biggest U.S. home lenders more than $68 billion since 2007, according to data compiled by Bloomberg News. Much of the amount has stemmed from losses tied to Fannie Mae, Freddie Mac and the FHA, which together buy or insure more than 90 percent of new mortgages.

‘More Onerous’

Fannie Mae and Freddie Mac have drawn $170 billion of U.S. aid since being seized 2008. The companies are under orders from their regulator to recover as much as they can for taxpayers.

Lenders’ contracts with Fannie Mae and Freddie Mac allow them to force buybacks of mortgages if the loan originators fail to properly vet debt, such as by accepting inflated borrower incomes or appraisals. Flawed paperwork can lead to pressure from Fannie Mae and Freddie Mac even on performing mortgages.

“Documentation standards are getting more and more onerous because no one wants to manufacture an imperfect loan, even if the imperfection is really insignificant,” said Quicken Loans CEO Bill Emerson, who leads the eighth-largest U.S. home lender and No. 1 online mortgage originator.

The response by his Detroit-based company includes having each of its loans reviewed by a second underwriter to ensure the quality isn’t later questioned, Emerson said in an Oct. 11 interview during the Mortgage Bankers Association’s annual conference in Chicago.

Septic Tank

MortgageAmerica has had to deal with repurchase demands for seemingly minor issues or ones outside a lenders’ expertise, according to Johnson. In one case, the septic tank for a home was located slightly beyond the mortgaged property. The natural response, he said, is to limit lending.

The Justice Department sued Deutsche Bank AG (DBK) in May for more than $1 billion for alleged failures by the company’s shuttered lending unit to meet FHA standards. The U.S. sued under the False Claims Act, which allows damages three times the size of loss. Deutsche Bank has said the case targets conduct that occurred before it bought the unit and a spokeswoman for the company called the allegations “unreasonable and unfair.”

Lenders are probably “overcompensating” for the risk they face from soured mortgages, said Robert C. Ryan, a senior adviser to the head of U.S. Department of Housing and Urban Development, which oversees the FHA. “We’re not in the business of trying to scare lenders.”

‘The Right Balance’

The government must “strike the right balance between providing financing and access to borrowers and, at the same time, making sure the loans originated are fair and sustainable for the borrowers,” Ryan said in an interview.

Freddie Mac is doing what it should to protect itself and taxpayers, and is being reasonable in its demands, said Brad German, a spokesman for the McLean, Virginia-based firm.

“We don’t want to pay for mortgages that should never have been sold to us,” German said in an interview. “When minor defects in a loan file are found, it does not necessarily trigger a repurchase; it triggers a request to the lender to remedy the defect, either by finding a missing document or taking similar corrective actions.” Andrew Wilson, a spokesman for Washington-based Fannie Mae, declined to comment.

“Mortgage originators are more closely adhering to underwriting guidelines resulting in fewer of the mortgage defects of prior years,” said Corinne Russell, spokeswoman for the Federal Housing Finance Agency, which regulates so-called government sponsored enterprises Fannie Mae and Freddie Mac. “This lowers default risk to the GSEs.”

‘Substantial’ Relief

President Barack Obama’s latest push to help more borrowers refinance into cheaper rates may hinge on the effectiveness of changes to Fannie Mae and Freddie Mac repurchase rights. FHFA acting Director Edward DeMarco told reporters yesterday that the companies would offer “substantial” relief from buyback demands without providing “blanket or absolute” protection as they expand the federal Home Affordable Refinance Program for borrowers with little or no equity in their houses.

While the average rate on a 30-year fixed loan was 4.11 percent in the week ended Oct. 20, the historically low costs don’t capture the “very, very harsh underwriting standards” that potential home buyers face, said Ron Peltier, CEO of HomeServices of America, the property brokerage owned by billionaire Warren Buffett’s Berkshire Hathaway Inc. The process is “the most embarrassing, difficult thing you can imagine,” Peltier said in an Oct. 13 interview at Bloomberg headquarters in New York.

‘Gone too Far’

The average time between mortgage application and closing rose to about 52 days last year, three weeks longer than in 2008, according to J.D. Power and Associates surveys.

Pressure from the GSEs has “definitely stanched the flow of credit to the mortgage market, but we had clearly gone too far,” said Richard Eckert, an analyst in San Francisco at securities firm B. Riley & Co. who wrote research on subprime lenders during the housing boom and then joined a hedge fund betting against property loans during the collapse. “We’ve got to return to some kind of happy balance.”

Bank of America Corp. (BAC) has scaled back mortgage lending as CEO Brian T. Moynihan prepares for new capital requirements and grapples with demands that it compensate investors including Fannie Mae and Freddie for losses.

‘Increasingly Inconsistent’

“Our repurchase experience with the GSEs continues to evolve and their repurchase requests and resolution processes has become increasingly inconsistent with our interpretation of our contractual obligations,” the Charlotte, North Carolina- based bank said in a slide presentationlast week.

Terry Francisco, a spokesman for Bank of America, had no immediate comment. Wells Fargo & Co. (WFC), the largest U.S home lender, had no comment, according to Vickee Adams, a spokeswoman.

The prospect of reimbursement demands has hurt home sales, said Brian Chappelle, a partner at consulting firm Potomac Partners LLC, during a panel at the mortgage conference. While the FHA allows down payments as low as 3.5 percent from borrowers whose credit scores are at least 580, lenders are setting the bar higher, such as at 620, he said.

Lenders “feel like they’re being held accountable for things beyond their control,” he said. “The only thing the industry can do is tighten up on the front end.”

Vision Mortgage Capital President Regina Lowrie has her staff conduct extra quality-control reviews on all of its loans before closings, up from 10 percent before housing slumped. “That adds cost to the process,” hurting consumers who ultimately must pay for the work, she said at the conference.

The unit of Plymouth Meeting, Pennsylvania-based Continental Bank also started taking additional looks at consumers’ credit files shortly before completing loans, based on Fannie Mae and Freddie Mac guidance, Lowrie said. It finds more situations like the potential borrower who took out a new car lease while waiting for the application to clear, “and now that loan’s going back to underwriting again,” she said.

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