Melvin L. Watt, the overseer of Fannie Mae (FNMA) and Freddie Mac, is loosening rules that have forced banks to buy back billions of dollars worth of flawed home loans in an effort to spur the housing market.
Watt, who took over in January as head of the Federal Housing Finance Agency, will announce in a speech today a series of steps intended to stimulate lending. More than six years after the housing bubble burst, lenders remain cautious about making home loans to borrowers with less-than-perfect credit because they could end up absorbing losses if the loans default.
The banks’ reticence has kept first-time homebuyers and others with weak credit out of the real-estate market and created a drag on the fragile housing recovery. Fannie Mae and Freddie Mac (FMCC) have forced banks to repurchase defaulted home loans with a balance of $81.2 billion between 2011 and 2013 alone. Lenders say that is a major reason they’re still requiring credit scores averaging about 740 on loans they sell to the government-owned mortgage companies, far above the sub-700 average before 2007.
Banks “have history in the rear-view mirror, and they don’t want to ever repeat that,” David Stevens, president of the Mortgage Bankers Association, said in an interview.
With Fannie Mae and Freddie Mac now guaranteeing two-thirds of U.S. mortgages, their actions have a broad influence on lending. Banks say the companies’ campaigns to make them repurchase $81.2 billion in home loans between 2011 and 2013 alone is a major reason they’re still requiring credit scores averaging about 740 on loans they sell to Fannie Mae and Freddie Mac, far above the sub-700 average before 2007.
The new rules that Watt will announce today in Washington are a first step in a long-term effort to clarify loan-buyback policies and ease lender concerns. Banks will be freed of liability for mortgages with three years of steady payments even if borrowers send their checks late twice during that time. They’ll also be off the hook for loans that pass underwriting spot-checks before the three years are up. Fannie Mae and Freddie Mac will begin notifying lenders in writing when they’re relieved of responsibility for each loan.
Details of Watt’s speech were provided to Bloomberg News by the FHFA.
Fannie Mae and Freddie Mac also will stop automatically issuing repurchase requests when private mortgage insurers rescind coverage on loans. Such insurance is required when borrowers make a down payment of less than 20 percent.
The changes “are important steps towards balancing safe and sound lending with improving access to credit,” Watt said in an e-mailed statement. “These changes should provide the lending community with additional clarity and confidence in making their lending decisions.”
In his speech, Watt is expected to outline a broad series of new policies governing the two mortgage-finance companies. It will be the first public appearance for Watt, a former Democratic congressman, since he took the lead at FHFA.
In addressing the issue of loan buybacks, also called putbacks, Watt is answering concerns raised by Federal Reserve Chair Janet Yellen, who told Congress on May 8 that the “flattening” housing market “will bear watching.”
New home sales dropped 14.5 percent to a 384,000 annualized pace in April, the weakest since July, according to Commerce Department data. The slump was concentrated in homes priced less than $300,000, showing that entry-level borrowers are being kept out of the market as prices and interest rates rise, and credit remains tight.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said Fannie Mae and Freddie Mac loan putbacks were partly to blame in an April 9 letter to shareholders.
“These issues make mortgages more costly and unpredictable for companies and far less consumer-friendly,” Dimon wrote. “In many cases, deserving lower- and middle-income consumers may pay far more than they might have in the past for a mortgage or, worse yet, they won’t be able to get one.”
Fannie Mae and Freddie Mac provide liquidity to the mortgage market by buying loans and packaging them into securities. Lenders who sell loans to the two companies sign so-called representations and warranties guaranteeing that the mortgages meet specific underwriting standards; if it turns out that the loans didn’t meet those requirements and later default, that agreement allows Fannie Mae and Freddie Mac to demand that the lenders buy them back.
The problem, lenders say, is that they’re sometimes asked to repurchase mortgages that were originated many years earlier and it isn’t always clear what constitutes a serious underwriting flaw.
“How do you separate foot faults from what would be otherwise material or egregious mistakes in loan documentation?” Stevens said. “For how many years should you be accountable ultimately for a file or documentation error?”
As the housing market collapsed in 2008, Fannie Mae and Freddie Mac were placed into U.S. conservatorship and required $187.5 billion in taxpayer funds to stay afloat. Under the direction of the FHFA, the companies combed through defaulted loans that were originated during the bubble years, from 2005 to 2008, to make sure that banks paid when defaulted loans shouldn’t have been originated in the first place.
The housing bubble was fed by millions of mortgages issued by banks to people with subpar credit, and the buyback program was designed to make sure all of the cost didn’t land on taxpayers.
Both companies largely finished their reviews of those legacy loans at the end of 2013. Now, after banks bought back $37.8 billion of those old mortgages last year alone, Fannie Mae and Freddie Mac’s heightened reviews of newly originated loans are causing banks some concern.
“The legacy issue is largely gone, and they’re focusing their resources now on all of the performing loans,” said Tim Rood, chairman of Washington-based housing-policy consulting firm Collingwood Group LLC. “It feels to lenders a little bit like adding insult to injury.”
The steps Watt is announcing today are just a beginning of the effort to ease lenders’ concerns. The FHFA is also considering allowing banks to fix some curable defects such as missing paperwork instead of automatically requiring buybacks when such flaws are found. The agency may also set up an independent arbitrator to weigh in when lenders and Fannie Mae or Freddie Mac can’t agree whether a loan is defective enough to require a repurchase.
“We know there is more to be done,” Watt said.
The agency started making changes to its buyback rules in January 2013, when Watt’s predecessor, Edward J. DeMarco, declared that lenders would no longer be liable for loans with three years of on-time payments. The FHFA also began checking a sample of mortgages soon after origination to flag potential problems long before the loans went bad.
Marianne Sullivan, a Fannie Mae senior vice president, said the early checks have already helped lenders improve the quality of loans they produce because the company provides training when it uncovers a pattern of, for example, improperly computed income or appraisals.
Newly originated loans in Fannie Mae’s book of business tend to stand up to scrutiny compared to mortgages issued during the bubble years. Only 0.25 percent of loans issued between 2009 and 2012 have been subject to a repurchase, compared to 3.7 percent of those originated between 2005 and 2008, according to Fannie Mae data.
Credit has begun easing slightly, a trend that Fannie Mae Chief Executive Officer Timothy J. Mayopoulos attributed to rising interest rates that have sapped the refinancing boom as much as to the efforts to improve certainty around loan repurchases.
Interest rates on 30-year fixed-rate mortgages rose from a record low of 3.31 percent in November 2012 to 4.58 percent in late August, according to Freddie Mac surveys. Rates fell last week to 4.21 percent. Wells Fargo & Co., the biggest U.S. home lender, in April cut its minimum credit score for borrowers of Fannie Mae and Freddie Mac-backed loans to 620 from 660, following similar moves from smaller banks.
“We are seeing that lenders are removing some of the credit overlays that they had previously put on when loan production was quite high,” Mayopoulos said.
That easing is only going to help on the margins, said Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute in Washington.
To broaden credit availability, it will be important for the FHFA, Fannie Mae, and Freddie Mac to set out a clear timetable for improving the buyback process, she said in an interview.
“I don’t think you have the overlays removed until the situation is clarified,” she said.
Studying loan performance data released by Fannie Mae and Freddie Mac, Goodman concluded the companies could relax their buyback requirements even further than they have without incurring major losses. She recommended that the companies relieve lenders of liability after only two years of on-time borrower payments.
For now, lenders including Wells Fargo say they’re encouraged by the steps FHFA is taking.
“The importance of certainty around how we manufacture loans, and what constitutes a defect, is part and parcel to bringing back the mortgage market that we all want to have,” Wells Fargo Executive Vice President Peter Diliberti said in an interview.
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