What the future could look like for U.S. home mortgages

Although the prospects for the U.S. housing finance market are currently bleak, a disciplined remodeling of the residential mortgage market could bring about a slow and steady return of private capital and help borrowers sleep easier at night, said industry executives speaking at a panel discussion during Standard & Poor’s Housing Summit: Boom, Bust and Beyond on June 9.

The panel, “Mortgaging The Future? The Evolving Landscape Of U.S. Housing Finance,” moderated by Matthew Albrecht, Associate, Financial Institutions, Standard & Poor’s Ratings Services, brought together three industry experts to talk about what might be in store for borrowers and lenders. Erkan Erturk, Ph.D., Senior Director, Structured Finance, Standard & Poor’s Ratings Services; Robert Partlow, Senior Vice President, Consumer Bank Portfolio, Sun Trust Bank; and Anthony “Tuck” Reed, Senior Vice President of Capital Markets, Wells Fargo Home Mortgage, participated in the panel.

Mr. Albrecht noted that government-backed enterprises have purchased, guaranteed, or insured nearly all new mortgages over the past few years, a significant evolution from 2006, when government had a direct hand in just about 40% of new issuance. “The risk return proposition just remains too unfavorable for private capital to commit,” he said. With the winding down of Fannie Mae and Freddie Mac and refocusing of other government housing programs, the congressional subcommittee on capital markets and government-sponsored entities (GSEs) is considering three options for housing finance reform. The first would limit government’s involvement to programs targeted for low and moderate income borrowers. The second plan would include a government guarantee that could be escalated in a crisis. In the third proposal, the government would also provide catastrophic reinsurance for mortgage guarantors.

Another consideration in the new mortgage landscape is the Dodd-Frank mortgage risk retention proposal. Under that plan, mortgage originators would need to retain reserves of at least 5% of any loan that’s not considered a “qualified residential mortgage”–where the borrower makes at least a 20% down payment and meets more stringent debt-to-income ratios among other underwriting standards. GSEs, however, would be exempt.

“Risk retention is a healthy thing–and might be absolutely vital for the return of private capital,” said Mr. Reed. But it will require a lot more capital to get the private-label housing finance market back on track. “The challenge is enormous, but it is manageable because we have the time and the tools to approach problems that will break the paralysis we are in today,” said Mr. Reed.

The housing market post-crisis appears to be on a more level playing field. There’s a more disciplined credit environment, and a trickle down effect of reform decisions will likely play out, according to Mr. Partlow. The form of the government guarantees will affect the price of the housing bonds, which in turn will affect the price of mortgages.

Yet the comeback in the U.S. private-label residential mortgage-backed securities (RMBS) won’t happen any time soon. “A meaningful recovery in this market is still years away,” said Mr. Erturk. The struggling housing market is directly correlated to the recovery of the private-label housing finance market, according to Mr. Erturk. In addition, housing reform has yet to be implemented and will likely proceed at a slow pace. “In the long run, the market for private-label RMBS could be much smaller, but stricter underwriting guidelines could bring the focus to more prime products,” Mr. Erturk said.

While there will be some hybrid loan products on offer and higher rates will prevail, the 30-year fixed-rate mortgage looks like it’s here to stay, according to the panel. “Borrowers prefer fixed rate because they want more certainty,” said Mr. Partlow. “There is something very comforting about knowing that rates won’t change,” said Mr. Reed. “It helps people sleep at night,” he continued.

The definition of “affordability” has also changed in today’s U.S. housing finance market. According to Mr. Reed, the definition needs to go back to what is sustainable for the borrower for the long term and not just in ideal circumstances.

And with U.S. regulators and policymakers extending the comment period on their proposed risk retention rule to Aug. 1, it’s clear that housing finance reform will proceed at a measured pace.

For the full report, click here.


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