I recently read an article by Jack Welch about candor in the workplace and with others. It discussed the need for candor in setting direction and strategy for a company. It talked about the difficulties and hurdles that needed to be overcome.
In reflection about this concept in the workplace and my own experiences I thought I would elaborate on my own beliefs and opinions.
Over the years I have had the opportunity to manage several firms. In retrospect on what made them successful came this philosophy.
Openness and candor must be a top down situation. The top person must embrace the concept. Too many times if the top executive is unsure of their own skills or too self centered they will not see the beauty of a team running smoothly and efficient.
Developing management that can see the vision of their leader and be able to craft the business plan and implement it, takes a diverse group of individuals who are good at the detail level.
Working in harmony provides the blessing to see ideas flourish when nurtured.
We can only succeed when working together provides the blueprint for success.
When the greater group takes ownership of the strategy it will win.
The final step is to provide an atmosphere whereby those that want to learn and take on more responsibility are rewarded not just monetarily but by showing them that you see their effort and thank you for it. It will make the difference between a job and a career. It will promote a happier workforce when they know the direction of the company and that they are part of the solution.
As we enter a period of uncertainty in the housing finance industry lets pause to take a moment to reflect the importance of Mortgage Servicing Rights (MSR) to the participants in mortgage lending.
As lenders approve and close mortgage loans for borrowers either purchasing a home or refinancing their existing homes, a mortgage servicing asset is created for the lender.
The lender may either decide to keep the responsibility of collecting the mortgage payments from the borrowers while providing all of the servicing duties expected by the investor and required by regulation or law.
If the Lender may hold the mortgage in their portfolio or sell the mortgage asset, they may decide to service the loan or sell off to another entity the mortgage servicing rights to that particular loan.
When a lender transfers the mortgage servicing rights to another entity it typically assumes the duties and responsibilities for servicing that loan but also any potential origination reps and warranties from the original lender. Any breach in these original reps and warranties after the culmination transfer of the MSR is the duty and expense for the new servicing entity. Thus due diligence is critical when acquiring MSR from a lender you may not be familiar with how this lender originates loans.
Today with new state and federal regulations governing mortgage servicing the value of this asset is under attack. Typically the fee earned for mortgage servicing is a percentage of the interest collected. The fee is based upon the outstanding loan balance of the particular loan. Thus as the balance of the loan decreases the mortgage servicing rights diminishes making it difficult to perform the expected duties profitably if the loan does not prepay early.
With all of the added duties today prescribed by State and Federal authorities it is uncertain what will be the overhead costs to perform these added duties. These new regulations affect both new and existing mortgage servicing portfolios.
All of these factors will have to be modeled by the larger mortgage servicing entities and be reflected in the premiums these entities will pay to originating lenders in the future.
One unanswered question will be whether small lenders wishing to retain the mortgage servicing rights of these loans will be able to efficiently service the loan profitably while maintaining the customer relationship. Small lenders servicing mortgage loans less than 5,000 will be exempt from some of the new federal laws but this may be only a temporary relief. These small lenders will still be subject to State laws governing mortgage servicing depending on where the loans reside.
It is estimated that the value of the MSR may see the reduction in the servicing rights premium by al least one multiple.
Many consumers today wonder with mortgage rates at all time lows should they prepay their mortgage? Let’s assume for this discussion that you have a new mortgage at 3.50% for a period of thirty years.
Some would say that you should keep that low mortgage rate for as long as you can. The thought being your money could earn you more if you invested those funds.
Others would say that a penny saved is a penny earned. Every chance to prepay is the best investment option.
What I am going to do is show you which might be the right choice depending on certain assumptions that may or may not hold true over time.
“Time” is always a huge guess when it comes to determining which alternative investment is correct for you.
Let’s analyze the option.
You could apply $1,000 down on the mortgage and reduce the principal balance and therefore save he interest that would be charged on that amount. You need to look at what investment option you could invest those funds. Clearly if you invest it in a bank account earning a rte of 1%.
Recently Ed Demarco, the acting Director of the Federal Housing Finance Agency (FHFA) outlined the 2013 Scorecard for the two government sponsored enterprises (Fannie, Freddie) that are still under conservatorship after almost four years.
The Scorecard is an attempt to explain what the regulator expects from its two entities it supervises as strategic goals to work towards during the year.
Two items have caught not only my eye but many others. The first goal of note was to state the creation of a new entity that will be initially funded by the GSEs but able to spin off as the public and Congress may so desire. This entity will consolidate all back room functions of both entities on a new technological platform that will be designed for the future needs and demands of mortgage backed securities. It will attempt to resolve some of the issues that surfaced during this past depression we seem to be departing from at last.
This is clearly a bold move of the acting Director to create the future housing industry while Congress basked in turmoil and mistrust of one another.
Mr Demarco seems committed to developing this company and strategy with industry input. The company will have its own governance with a board of directors, a Chairman and a Chief Executive Officer. It will be located separately from the current GSEs.
The second bold initiative is to cause the GSEs to develop, market and issue up to thirty billion dollars in mortgage backed securities with a credit enhancement facility sponsored by private enterprises. This will reduce the exposure of mortgage default to the taxpayers in the future.
Once this has occurred and the loan production going to the GSEs flowing into securities why not dramatically cut down or close the current Fannie and Freddie companies and staff reducing the dependence on these companies in the future.
Only when these two objectives are accomplished will we truly be able to focus on the future of the housing industry and prepare for the needs of our communities. These needs could be more into multi-families units than single family units.
I was recently reviewing a survey of banking executives about their expectation of the housing lending industry. Some of the areas of my concerns are the following:
Respondents stated they were confused about all the new regulations
Many felt that new regulations will require additional staff to manage compliance.
The majority of respondents felt that volume would increase by five to ten percent over 2012 levels
On the surface the new regulations will be burdensome for some lenders. Technology should help this issue if the lender has experienced personnel
During the past two years mortgage rate have either lowered or stabilized. This allowed both lenders and borrowers the time to consider refinance options and process them in time.
But let’s look at the current market rates for thirty year fixed rates. The average posted rate for Freddie, one of the government sponsored enterprises was about 3.45% last week this average had moved up to 3.51% the anticipated rate by the end of the year is expected to be 4.0% as noted by the Mortgage Bankers Association of America.
If mortgage rates are expected to go higher, then the refinance volume will drop significantly since there will be no financial benefit to the borrowers.
New home construction is showing improvement as a percentage but when you consider how low it dropped any small amount of new homes will show a dramatic increase percentage.
In 2012 most bankers saw that refinance loans accounted for 70% of their total volume. Without some significant event 2013 will be dramatically lower than 2012
The is a silver lining for these bankers expectations. Currently there is proposed legislation in Congress to allow Fannie/Freddie the two GSEs to purchase loans that were sold to other investors that cannot refinance because of their current loan to value as a result of the drop in home values over the past years.
This would open up thousands of borrowers to the option of refinance. Bankers could unload loans that they did not want to keep in portfolio but earn fee income for the sale of these mortgage requests.
The danger is that some of these loans will default and the GSEs will suffer losses that will ultimately be borne by taxpayers.
Some have questioned why the increase in the guarantee fees paid will drive up mortgage rates over time. Lets look at the basic construct of a mortgage backed security
First you begin with the required pass-thru rate which will be paid to the investors (Exhibit One).
Next the allotted mortgage servicing fee is added to the required pass-they rate.
Finally the agreed upon guarantee fee is added to the pass thru rate and the servicing fee to create the minimum note rate that can be added to the mortgage backed securities.
Now that we understand the basic structure of a mortgage backed security we can consider the effect of increasing the guarantee fee.
Lets assume the typical guarantee fee of twenty-five basis points. If the pass thru rate is 3.50% for thirty year mortgages, add .25% for the mortgage servicing another .25% for the guarantee fee then the minimum note rate will be 4.00%
If the Director of the Federal Housing Finance Agency who oversees both Fannie and Freddie decides to increase the guarantee fees then minimum note rates will increase automatically.
We know that the Director intends to increase the guarantee fees until such time as Private Investors return to the market making loans and reducing the dependency on Fannie and Freddie.
This action will cause mortgage rates to go up while inflation remains level.
Will this action dampen the housing industry recovery? At what level will private investors return to the market where they feel the mortgage risk is covered sufficiently.
The Federal Housing Finance Agency has recently published its strategic plan for the Government Sponsored Enterprises (GSEs) and to cure some of the issues that the recent housing crisis has illuminated.
The plan is to begin the process of creating an alternative market infrastructure that investors could rely on in the future if the GSEs had to be shut down.
The elements of this plan includes the following:
- A framework to connect the capital markets to homeowners by which a securitization platform that bundles mortgages into an array of securities structures while providing all of the operational support to process and track payments from borrowers through to investors.
- Standardization of pooling and servicing agreements that replace the current GSEs’ current Servicing Participation Agreement, correcting the many shortcomings found in pooling and servicing agreements used in the private-label mortgage-backed securities market.
- Clear and understandable servicing requirements that set forth responsibilities to borrowers and investors across the full spectrum of issues involving servicing the loan, soliciting for refinance or loan modification options and servicing transfers.
- Servicing compensation that promotes competition than concentration of mortgage servicing.
- Identifying the detailed, timely and reliable loan-level data for mortgage investors at the time of securities issuance and the life of the security.
- A sound and efficient system for document custody and electronic registration of mortgages, notes titles and liens that respect local property laws but also enhances the liquidity of mortgages.
- An open architecture for all these elements to facilitate entry to and exit from the marketplace and the ability to adapt to emerging technologies.
In the short term, the GSEs have been asked to create a single platform for mortgage-backed securities. This is the first step in the possible consolidation of the two GSEs by requiring both to use a single platform and provide identical agreements. Over time the structure would be available to any secondary market participant ensuring liquidity and standardization as a central theme.
Building for the future secondary mortgage market also requires the development and implementation of underwriting, disclosures and servicing considerations. Creating strong pooling and servicing agreements is key. Developing these items will take input from investors and Securities and Exchange Commission rules
The plan also requires the GSEs to reduce their portfolios over the next several years.
Accomplishing these tasks will be very difficult in light of the uncertainty in the housing industry. There are many regulations that need to be defined in order to progress forward. The requirements for the “Qualified Mortgage” and the “Qualified Residential Mortgage” need to be established in order for the process to begin.
Currently these two definitions will be finalized some time in January 2013. At that point leaders of the Housing Finance Industry may be able to begin to move forward.
This action is being taken by the Acting Director of the Federal Housing Finance Agency because of the inaction of both the White House and Congress. These two entities still have no idea or the fortitude to formulate a plan to move forward with the housing finance industry. The public has endured over three years of the GSEs being in conservatorship. No other organization would have been allowed this long a period to wallow around with no direction.
Right or wrong I applaud the acting director Edward Dimarco for at least having the courage to show leadership.
Lets all contact our legislative members of Congress and tell them we sent them to Washington to do a job. This is not going to be an easy solution but we must stop kicking the can down the road. The time is now to show the strength of conviction and do what is right.