The health of the real estate market improved markedly in 2013, yet mortgage lending and the securitization of loans are still on government life support.
Experts have been taking residential lending's vital signs, but their prognoses are mixed. Some believe nonagency securitization will rise this year, albeit modestly. Others say new government lending rules and continued dominance of Fannie Mae (FNMA) and Freddie Mac (FMCC) will limit any small rebound in nonagency securitization.
With securitization, investment banks pool contractual debt, such as residential or commercial mortgages, credit card debt or auto loans, and sell this pooled debt to investors as bonds or other investment instruments. Residential mortgage-backed securities and commercial mortgage-backed securities are two typical pool types.
At the end of December, credit-rating service Standard & Poor's issued its 2014 outlook, "U.S. Housing and Residential Mortgage Finance," stating: "We expect nonagency securitization volume in 2014 to reach almost $40 billion. This is approximately 30% higher than the 2013 expectation of $29 billion.
Lending experts take issue with the report. "We have really yet to see of any recurrence of any private securitization market," said David Stevens, CEO of the Mortgage Bankers Association.
He says the total lending market in 2013 was $1.7 trillion and will be $1.12 trillion in 2014, nearly all of it backed by the GSEs — Fannie Mae and Freddie Mac. So, he added, "we are a long ways away from relieving ourselves from our overdependence on the government.
"The securitization markets are still not ready to operate at scale and likely won't be in 2014," said Brad Blackwell, executive vice president at Wells Fargo (WFC).
Rules And Ratings
What's limiting private securitization? Again, answers are mixed. But the new qualified mortgage (QM) rules, which took effect Jan. 10, aren't helping, say experts. The new Consumer Financial Protection Bureau rules are a strict set of lending guidelines, intended to ensure a borrower's ability to repay the loan.
Learning the new rules is making lenders skittish enough, but not adhering to these standards has a specific legal bite. Under the QM rules, banks are legally liable when they issue loans to clients deemed unable to make repayments.
So non-QM lending is riskier. "There's a lot of uncertainty over that (legal obligation) and a lot of risk for nonqualified loans," said Mary Ann McGarry, CEO of Guild Mortgage in San Diego.
Furthermore, experts say if loans get packaged for investors, into nongovernment-backed securities, those need to be rated.
But the real estate bust and the crash of the mortgage bonds market brought criticism of the ratings agencies for inadequately scrutinizing mortgage securities.
There is an "extraordinary lack of confidence in the ratings agencies," said Stevens.
Sharif Mahdavian, analytical manager for S&P's residential mortgage-backed securities ratings, says several steps are needed to attract more private money back into securitizing loans.
If the private market securitizes mortgages again, lending would ease as banks would have another outlet for selling debt off their books. But investment banks need to grasp what they're securitizing, and investors in these financial instruments must have confidence they know what they're buying.
Mahdavian said there needs to be "more transparency in the marketing of nonagency securities ... more robust reporting on a loan level basis and more confidence in the due diligence done on the loans.
Some banks are doing non-QM loans and buying QM loans from smaller lenders. Wells Fargo is one. Others include JPMorgan Chase (JPM) and Bank of America (BAC).
Wells is making QM- and non-QM jumbo loans to "strong borrowers with a strong ability to repay," said Blackwell, adding, "We are not securitizing any of our nonagency business and don't intend to do so in 2014. We like the returns and quality we're getting with nonconforming mortgages.
Blackwell says his operation at Wells Fargo also will continue to buy and hold in its portfolio loans from "correspondent lenders that meet the QM rules" in 2014.
Blackwell said that "nonconforming interest rates today are lower than conforming ... and that's a barrier to private securitization coming in." He notes that nonconforming rates stand a quarter of a percent lower for 30-year, fixed-rate mortgages and "as much as 3/4% lower" for adjustable rate mortgages that are fixed for five years and adjust annually.
He says these lower rates are less attractive to entities that might want to securitize loans, since returns are lower and risk higher.
So who is securitizing non-GSE mortgages, according to S&P? Real estate investment trusts such as Redwood Trust (RWT) and Two Harbors Investment (TWO).
S&P officials admit it's a small part of the overall lending market, but it's finally showing growth. "When we wrote this report, we were talking about a nonagency market that has been virtually dead for the past few years," said S&P's Mahdavian. "Forty billion . .. it's still extremely small ... but it's a positive pattern.
Mahdavian also says lending will continue to be tight for real estate investors in 2014. "It's very hard for investors in this environment," he said. "The default expectations for investor loans are higher" than for owner-occupied loans.
Also, investors are facing much more competition for properties with investment potential from REITs and hedge funds.
Carrie Nikols, principal and chief lending officer at Nikols Co. in Newport Beach, Calif., says her company used to provide funding to investors rehabbing and selling foreclosures. With those investments becoming scarcer, and financing for homebuyers tighter, her company is doing 12-month bridge lending to commercial real estate investors. These are borrowers who are "restructuring or acquiring a distressed asset for repositioning," she said.
A small boost for the private securitization market is coming from government-sponsored enterprises themselves. The GSEs have committed to doing more risk-sharing bonds in 2014, securities created by the GSEs and sold into the private market. The GSEs have made three such offerings, two by Fannie Mae and one by Freddie Mac.
"The GSE risk-sharing transactions have had huge popularity," said Mahdavian.
The Mortgage Bankers Association has been actively pushing a proposal to enable even more risk sharing with GSEs at loan origination, by a borrower "getting private mortgage insurance, covering the first 50% or 60% of the loan (or potential loss)," said Stevens. "This would shift the risk away from the taxpayer and more to the private insurance business" and private sector.
Stevens says loans, under this proposed program, likely would be competitive or potentially cheaper than today's mortgages.
That's because although borrowers would buy more mortgage insurance, the GSEs could lower their guarantee fees because they'd be exposed to less risk.