Risky credit shunned by Wall Street

The secondary mortgage market, which has grown increasingly more powerful in recent years — driving many decisions made by originators and servicers — now broadly acknowledges a need for more due diligence on its part.

At least some motivation is fear that if the sector does not self-regulate, lawmakers and regulators will force them to do so.

Regardless of what drives the stricter vetting of loans, it will reduce the availability of credit for home purchases, refinancing and equity access — especially at the outer margins of creditworthiness, where lending has grown extensively the past few years.

For those higher-risk borrowers, “there are severe liquidity restraints affecting underwriting criteria,” says Damien Weldon, vice-president of collateral and prepayment analytics at LoanPerformance in San Francisco. But, Weldon says, “There is no credit crisis in mortgages for the average borrower.”

Indeed, a research report out this week from the University of Pennsylvania’s Wharton School indicates that traditional 30-year fixed-rate mortgages have survived the “so-called mortgage meltdown, and home buyers are flocking to them.”

ARMs drop by half

Author Susan Wachter found third-quarter 2007 adjustable-rate mortgage applications had plummeted 46.9 percent from September 2006 to September 2007, while applications for fixed-rate loans in that period rose 30.2 percent.

“The liquidity is there for a borrower seeking a 30-year, performing nonprime, fixed-rate mortgage that goes straight to the GSEs,” says Mark Ryan, managing director, head of residential MBS trading, Bank of America Securities.

Ryan notes that, “The liquidity has never come out of that part of the market,” but “investors have backed off substantially from other (types of lending)” — representing a virtual freeze among investors no longer confident about the promised performance of many individual loans and pools.

Scott Samlin, executive director, Morgan Stanley, New York, predicts that, “In the future, there is going to be some onus on the investor to look at what the lenders’ best practices are and their own established practices and diligence.”

Concurring, Gregory Walker, managing director and managing attorney, UBS admits: “We have not done everything we possibly could in the area of due diligence.” Going forward, he sees “a more realistic view of borrowers (in which) FICO scores will be taken more into context. Someone who is 28 years old and making $70,000 a year may not be viewed the same way (as someone older).”

Walker takes to task some loan originators, notably mortgage brokers, who he says “are basically beholden to nobody.”

The GSE presence

Meanwhile, the perennial secondary market leaders, Fannie Mae and Freddie Mac, are attempting to “bring stability and trust back to the mortgage market,” says Patricia Parsons, director of product development, Fannie Mae, Washington, D.C., referring particularly to the subprime sector.

Fannie has funded “over $66 billion in such loans during the first half of 2007,” reports Parsons, who notes that the government-sponsored enterprise “will continue to step lightly into this business.”

Freddie Mac’s Becky Froass, senior director, industry and state relations, says 15 percent of the GSE’s portfolio consisted of subprime securities last year, down from a 25 percent high in 2003.

Freddie Mac, based in McLean, Va., may buy $9 billion in additional subprime securities this year, “but $5 billion is more likely,” says Froass, noting that “it’s not as much as we would have hoped for.”

She says confidently that “Freddie benefited from this year’s mortgage industry crisis, demonstrating the value of its GSE model.”