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Weekly UpdatesThe subprime lending frenzy of recent years has left the mortgage industry buried under a heap of rubble, where it is still searching for a stronger foothold upon which to rebuild. Though many lessons have been learned, there are surely others to be discovered. As for now, a general understanding has been reached about the need to revisit adherence to the many nuances of industry regulation.
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Compliance is on the minds of all industry professionals today. Some of this new emphasis derives from the recent increase in government-insured mortgages, where the program rules are complex and meticulously enforced. Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) mortgage products have gained strong preference over many of the riskier subprime loans and other non-traditional products, which are no longer available.
The Mortgage Bankers Association (MBA) issued a release on July 9 stating that mortgage applications for government-insured loans (FHA and VA) reached their highest level in June 2009--at 35.9 percent--since November 1990. According to data from MBA's Weekly Mortgage Applications Survey, the government-insured share is up 27 percent from June 2008, and made an impressive 25.7 percent jump just from the month prior.
This shift, accompanied by growing default and foreclosure activity, will ultimately contribute to a change in the makeup and maintenance of servicers' portfolios. And though real estate-owned (REO) management is currently the focus of many servicers, REO inventories will begin to cycle out, leaving the newer government-backed paper heavily represented in servicing portfolios.
With last year's surge in FHA origination volume, lenders experienced challenges in attempting quick, effective training and education on FHA origination procedures and regulations. To avoid similar frustration, servicers can look back to previous market cycles when FHA held a larger market share and learn how to prepare for the government-loan compliance burden that is sure to come.
The current economic recession, volatile marketplace and illiquidity in the private secondary market have caused an abrupt halt in subprime and non-agency lending, tighter credit standards, and increased federal oversight and regulation of the government-sponsored enterprises (GSEs). Due to the changes in the market, a significant rise in FHA market share has occurred over the past year to year and a half. According to Fannie Mae's June 2009 report, Economics and Mortgage Market Analysis, FHA market share as of the first quarter was slightly less than 19 percent--a dramatic increase from the meager 4 percent it represented at year-end in 2007.
A 2004 article from Apartment Finance Today quoted Todd Rodenberg, then chief operating officer of KeyBank Real Estate Capital, Cleveland, saying, "FHA is coming back."
It has taken a while--most likely far longer than Rodenberg anticipated--but as of 2009 FHA has clearly staged its comeback.
Then and now
Though levels of government-insured mortgages were not quite as high in 2003 (when they last peaked) as they are today, they were definitely prevalent in that period. From 2000 to 2003, FHA origination volume was on a steady increase. The same numbers used in Fannie Mae's June analysis show volume around $100 billion in 2000, then increasing approximately $25 billion annually over the next three years.
Though relatively short-lived, this uptick in government-insured mortgages likely was due to the general increase in mortgage application volume at the time and prevailing economic conditions early in the decade. As alternative products became available with looser restrictions and underwriting standards, the more stringent requirements of FHA loans led to a loss of market share.
From 2004 to 2007, FHA mortgage volume significantly declined. This dramatic decrease was primarily due to the emergence of a multitude of alternative subprime mortgage products that effectively replaced government lending.
A USA Today article from Dec. 7, 2004, reported that from 1994 to 2003, subprime mortgage activity grew on average 25 percent annually, eventually outpacing the rate of growth for prime mortgages. Subprime skyrocketed homeownership rates to record levels, and though concerns existed regarding its impact on future delinquency rates, it became a mainstream business venture signaling to many it was now possible for almost everyone in the country to participate in the American dream of homeownership.
Subprime quickly eroded what was left of FHA market share, particularly among those borrowers who traditionally were the meat and potatoes for the FHA program--low- and moderate-income borrowers and first-time homebuyers. When subprime crashed to a halt, FHA mortgages, in addition to VA, became viable product options once again.
The trend back toward safer government mortgage products showed the first signs of picking up when 2006 foreclosure rates on subprime loans more than doubled from where they were in 2005. Many of the firms that had specialized in these products experienced losses, ceased operations or otherwise began to exit the origination of such products.
This sequence of events was reported in an article in the Feb. 17, 2007, edition of The Wall Street Journal (WSJ). The WSJ article also stated that some of the more recent types of nontraditional mortgages--piggy-back loans, interest-only products and no-document mortgages--accounted for 47 percent of total loans originated in 2006, but were less than 2 percent of total mortgage loans originated in 2000.
Of course, many of the loans made under these subprime and nontraditional programs have since gone into default. Generally, there is an 18- to 24-month lag from the time of underwriting to default. These defaulted nontraditional and subprime mortgages, fueled by recent dramatic home price declines, have contributed to the present overwhelming REO inventories.
With rising foreclosures and defaults (the national foreclosure total just rose 27 percent in a single quarter) in addition to the sharp increase in FHA lending, the government-insured loans now being originated will soon be what is being serviced. With this dramatic shift in prevailing loan type will come changes to property preservation, loss mitigation and inspection requirements.
Industry in transition
Many things can be expected as REO assets continue to cycle out of lenders' inventories and the industry returns to more conventional underwriting standards. Compliance standards will become even more conservative than in the past. Regulators have already adopted a more conservative stance, and compliance requirements are widely expected to continue to grow in complexity and number. Already this year, a number of state and local ordinances have been put in place regarding the preservation and inspection requirements for homes. Municipalities in California, Texas and Maryland have been particularly active in this area. Several cities, most notably Los Angeles, Baltimore and Dallas, have published incentives recently that focus on vacant properties.
Just to put the complexity of these procedures in perspective, winterization (prevention of freeze damage) is required year round in Illinois and Indiana, no matter the month in which the property is secured. In Florida, no winterization is required except from the city of Jacksonville north to the Georgia line, and only from Sept. 1 through April 30. Arizona and California only require winterization for properties sitting above 2,000 feet.
Additionally, attention to loss mitigation for servicers has heightened. Both the nationwide attention surrounding the foreclosure crisis and the Department of Housing and Urban Development's (HUD's) Tiered Ranking System (TRS) are important reasons for servicers to place increased focus on this.
The TRS was introduced in 2000, first as a pilot program, to measure how effectively servicers were complying with HUD's program for loss mitigation. The system has four tiers, with ratings assigned to servicers based on their workout (WO) ratio (loss-mitigation activities). As a servicer, being ranked in either of the lowest two tiers means being subject to possible investigation and/or audit by the Office of Lender Activities, as well as being targeted for training by the agency's National Servicing Center (NSC).
Scores are released every quarter based on data that are calculated during a rolling 12-month period called a "round." The HUD Mortgagee Letter 09-04 issued on Jan. 16 of this year announced additional eligibility incentives available in the 2009 calendar year for FHA servicing lenders ranked in Tier 1 during the scoring period of Round 34, which began Oct. 1, 2007, and ended Sept. 30, 2008. The other incentives for pursuing loss mitigation, as stated in the mortgagee letter, include:
* A surplus payment for each additional special forbearance agreement executed on or after Jan. 1, 2009;
* An automatic (i.e., HUD's written approval is not required) extension of two additional months to continue to market properties being sold via preforeclosure sale; and
* An increase in the reimbursement of foreclosure costs from two-thirds to 75 percent for Part B claims received by HUD on or after Jan. 1, 2009, for loans endorsed on or after Feb. 1, 1998.
HUD is continuing its ranking scores for each quarter, and determination of eligibility for performance incentives will be provided annually as the department releases the scores at the conclusion of every fiscal year.
With the government supplanting the role of the private secondary market investors in the mortgage market, it is natural to expect a shift in oversight priorities. For example, regardless of a servicer's TRS ranking, HUD consistently tracks and reviews every active FHA servicer's use of the three loss-mitigation retention tools: special forbearance, mortgage modification and partial claim. Servicers will need to stay current with the loss-mitigation practices that are achieving success and take proactive steps to meet the challenges ahead.
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