BOSTON — Delinquencies and foreclosures will continue to rise in 2008, keeping Wall Street investors who bankrolled subprime mortgage loans that fueled the housing boom on the sidelines, industry executives said Monday.
Until investor confidence returns, FHA guarantee programs and mortgage repurchasers Fannie Mae and Freddie Mac will have to fill the gap, was the oft-heard mantra at the Mortgage Bankers’ Association annual convention in Boston.
“I think over the next 12, 24 months the new subprime is FHA, because there is no subprime market today,” Steve Nadon, president and chief operating officer of Option One Mortgage Co., said in a panel discussion.
“There is no liquidity for that market anywhere” for originators to sell their loans in order to make more loans, Nadon said.
The Federal Housing Administration’s loan guarantee programs “will play a huge role in the recovery of the market,” said Chase’s David Lowman, chief executive officer of global mortgage. Lowman said loans backed by FHA guarantees have already gone from making up 2 percent of loans in 2006 to about 4 percent now, and could become 10 to 12 percent of the mortgage market — although Congress will have to pass the FHA modernization bill for that to happen.
FHA-backed loan guarantees “are part of our DNA, but many loan officers that joined us in the last three to five years probably can’t spell FHA,” said Paul “Buck” Bibb, chief executive officer of National City Mortgage Co, joking that some may think it only stands for Federal Highway Administration.
Bibb said that in the last six months, National City has boosted production of loans backed by FHA guarantees from 2 percent to 11 percent to 12 percent. But a decade ago, Bibb said, “FHA was 30 percent of what we did — that was our ‘near prime’ product. FHA simply let that business get away from them. They did nothing to modernize the program.”
The Bush administration has made FHA guarantees the cornerstone of its efforts to help subprime borrowers. The new FHASecure program allows FHA, for the first time, to back refinance loans for borrowers who are already missing payments on their adjustable-rate mortgages.
Congress is also debating legislation that would expand the pool of eligible borrowers by lowering down-payment requirements and allowing FHA to introduce risk-based pricing. Using risk-based pricing, FHA could charge higher premiums to borrowers who previously would not have qualified for its programs.
But some worry that giving FHA too great a role could end up costing taxpayers in the long run. An editorial in Monday’s Wall Street Journal argued that FHA-backed loans perform worse than subprime, and that expanding the number of borrowers served could lead them to bleed more money than they generate.
Assistant Secretary of Housing Brian Montgomery said Monday that the foreclosure rate on FHA-backed loans actually dropped in the last reporting period, and that the loan guarantees generate a surplus. While the rapid rise in the use of seller-funded down-payment assistance was “moving us from a positive subsidy to a negative subsidy,” the rules for such assistance are being tightened.
“We are no longer going to be (generating revenue) … but we will not require an appropriation,” Montgomery said.
Since Sept. 4, FHA has processed 45,000 refinance loans, the overwhelming majority of which were subprime, he said. He projected 80,000 delinquent borrowers and 160,000 nondelinquent borrowers will be able to use FHA guarantees to refinance their loans this fiscal year. Widespread adoption of risk-based pricing could help FHA back an extra 120,000 purchase loans in fiscal 2008, he said.
Loan guarantees by the FHA or the government-sponsored entities Fannie Mae and Freddie Mac are crucial because investors have lost confidence in “private label” securities used to fund much of the lending during the boom.
“I would say it’s not really liquidity, it’s investor confidence that’s waned,” Chase’s Lowman said. “Jumbos will be first back, and last will be subprime. We need to do a lot to restore investor confidence.”
Secondary market investors won’t be coming back until there is enough “transparency” to determine the full extent of losses from delinquencies and defaults in securities backed by subprime loans — a process that will probably take until June, said Patricia Cook, Freddie Mac’s chief business officer.
“We are doing everything we can to provide liquidity to that end of the market,” Cook said, although caps on growth in the GSEs’ loan portfolios limit what they can achieve. “If at the peak, subprime lending was $600 billion a year, it’s hard to put together even a fraction of that,” she said.
Some lawmakers support raising the caps on the GSEs’ portfolios and also the $417,000 conforming loan limit. The Bush administration wants any such moves to be tied to stepped-up oversight of the scandal-plagued companies.
Lowman said he would support a temporary increase in the conforming loan limit, indexed to the cost of housing, to allow Fannie and Freddie to repurchase larger loans in high-cost areas.
“From our vantage point, we would want to see the agencies stick to their original mission, what they were put on earth to do — to provide affordable housing,” Lowman said. “We are in a crisis, and we would support temporary measures.”
Thomas P. Cronin, vice chairman of Clayton Fixed Income Services, said the secondary market for mortgage loans is “seized,” with securitizations of nonconforming loans declining 82 percent from December 2006 to August 2007.
Cronin said two months ago, the Mortgage Bankers Association’s board of governors held a special session to strategize a response to the crisis. He said the board decided to urge lawmakers to support an increase in the GSEs’ portfolio caps, and work with rating agencies to come up with better-defined ratings of mortgage-backed securities.
Cronin said the board also decided it was time to “get back on airplanes, the way we did 14 years ago” during a similar crisis, to persuade investors that the crisis had passed. But Cronin said an analysis of subprime loans made in 2007 revealed that lenders hadn’t tightened up their standards.
“The reality was things hadn’t gotten better,” Cronin said – loans made in 2007 were performing just as badly or worse than the 2006 loans. And a cutback in subprime loan fundings seemed to have led to more problems in alt-A loans.
Cronin said the next hurdle is when the interest rates on many of those loans begin to reset. He said 40 percent of ARM loans Clayton monitors will reset between now and the second quarter of 2008, and “16 percent are already 60 days or more delinquent.”
“Patience is a virtue,” Option One’s Nadon advised. “So look forward to 2009 as a recovery period, and not 2008.”