Despite an improved environment for single-family housing, significant challenges remain in U.S. agency and non-agency housing. A stronger economy should increase demand for housing and benefit loan performance, but loan modifications indicate that the sector still has room for improvement. Furthermore, Standard & Poor’s Ratings Services anticipates that historically low interest rates will support loan origination but remain an impediment to public agencies that develop affordable housing, especially single-family units.
Standard & Poor’s projects that the number of single-family housing starts will reach approximately 1 million in 2014, up from 530,000 in 2012, based on stronger employment. Our baseline projections for unemployment are 7.8% in 2013 and 7.3% in 2014, compared with the 8.07% actual rate in 2012. The increased income from higher employment translates to 3 million additional households, for a total of 125 million in 2014.
However, with a range of low short-term and long-term rates to compete with, housing finance agencies (HFAs), which aim to provide affordable housing, will continue to struggle to originate loans through mortgage revenue bonds. Because the economic recovery remains tepid, the Federal Reserve said on March 21 that it anticipated that unemployment would remain above 6.5% through 2014, in line with our projections. The Fed said that if these forecasts held true, it would keep short-term interest rates near zero. Furthermore, Standard & Poor’s projects that the 10-year Treasury note yield will reach no more than 2.61% in 2014. This historically low yield affects the 30-year mortgage rate, which Standard & Poor’s sees reaching 3.86% in 2014 in its baseline scenario.
Fannie Mae And Freddie Mac
We anticipate a continued strong role for government-supported entities (GSEs) even as we see greater activity in non-agency mortgage securitizations. Although the GSEs are seeking and evaluating different platforms for the participation of private capital, we believe that they are committed to supporting a recovering housing market. And despite the recent rise in home prices, a significant number of borrowers need modifications or other support to avoid foreclosure.
In particular, a recent approval from the Federal Housing Finance Agency (FHFA) will provide for streamlined loan modifications beginning this July for those loans backed by Fannie Mae and Freddie Mac. The modification program is designed to minimize administrative delays that may hamper the execution of a loan modification. The program, in our view, is further evidence of the agency’s support of a housing recovery. In addition, Home Affordable Refinance Program refinancings with loan-to-value ratios of more than 105% made up 43% of total refinancing volume in 2012 versus 11% in 2011. In terms of newer mortgage production, we see greater opportunities for GSEs to seek both credit risk transfer and also support private mortgage lenders through higher guarantee fees.
The FHFA has provided a representation and warranty framework to lenders that stipulates that all loans sold to Fannie Mae or Freddie Mac after Jan. 1, 2013 will relieve lenders of certain repurchase obligations for loans that meet specific payment requirements. For example, representation and warranty relief will be provided for loans with 36 consecutive months of on-time payments. Exceptions to these “sunset” provisions mainly relate to violations of state, federal, and local laws and regulations.
A Thaw In Private Capitalization
Greater clarity about lending practices emerged earlier this year. On Jan. 10, in accordance with the Dodd-Frank Act, the Consumer Finance Protection Bureau released a definition of qualified mortgages that limits upfront points and fees, bars specific loan features (such as interest-only and negative amortization), and caps debt-to-income ratios at 43%. On March 4, the FHFA announced its 2013 strategic plan scorecard, which calls for the execution of risk sharing transactions amounting to $30 billion unpaid principal balance of its current production. The strategy seems to coincide with the goal of contracting the significant presence of the GSEs in the marketplace. Accompanying this release in the same month was the release of loan performance data from Freddie Mac and a comment that Fannie Mae would soon follow with its release.
Concurrent with these actions, banks sought to clarify representations and warranties. We see two sides to the representation and warranty discussion. One side wants to ensure a commitment to solid underwriting and ensure alignment of interests through “skin in the game,” in which originators and aggregators are required to repurchase certain failed loans. The other side seeks to create a platform for strong third-party reviews of collateral as well as compliance with underwriting guidelines prior to securitization so that investors can evaluate loan quality. It is likely this debate will not be resolved while lenders are securitizing only the best loans. We believe these issues will resurface when certain borrowers who have FICO scores below the mid- to low 700s and can’t afford a 30%-35% down payment are once again able to get loans.
Overall, we believe that 2013 will see some meaningful shifts in the mortgage finance landscape. We are closely watching the development and finalization of risk retention rules, specifically the definition of qualified residential mortgages under Dodd-Frank.
Housing Finance Agencies
The biggest challenge for HFAs is loan origination as opposed to loan performance. State HFA single-family whole loan bond programs had an average delinquency rate (at least 60 days past due or in foreclosure) of 7.4% in the third quarter of 2012, the latest period for which data are available. This compares with 6.2% for state prime pools and 14.1% for state subprime pools. HFA loan performance has deteriorated somewhat since 2006, but has stabilized since 2010. We incorporate these delinquency rates into our loss assumptions, but in no instance has loan performance resulted in a negative rating action. And we do not anticipate that loan delinquency will trigger negative rating activity in 2013.
We do expect loan origination to remain challenging, at least in terms of bond programs. Competitive mortgage products and low interest rates have reduced the feasibility of financing loans through mortgage revenue bonds (MRBs). Instead many HFAs have implemented other loan origination techniques that do not rely on bonds. These include the sale of mortgage-backed securities (MBS) with Ginnie Mae guarantees to the “to be announced” (TBA) market, direct purchase loan participation pool sale to financial institutions, and whole loan sales to Fannie Mae or Freddie Mac. All of these examples differ from the traditional HFA model in that the HFA does not hold the loan after origination, thereby forgoing future revenue streams. In some cases HFAs have surpassed the origination levels they achieved with MRBs. The advantage to the alternative financing is keeping HFAs active in the financing business, although this comes at the loss of a stream of revenue. We believe that the benefits of non-traditional loan origination outweigh the downside and provide HFAs with diversification of revenue.
Although HFAs are the primary financiers of single-family housing in the municipal market, local issuers that included cities often used to finance loans through the tax-exempt market. That local issuers no longer significantly participate in the municipal housing market indicates the extent to which the industry has shrunk. We anticipate that the predominance of state housing agencies will continue for the near future.
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As The Market Recovers, U.S. Single-Family Housing Activity Builds
Despite an improved environment for single-family housing, significant challenges remain in U.S. agency and non-agency housing. A stronger economy should increase demand for housing and benefit loan performance, but loan modifications indicate that the sector still has room for improvement. Furthermore, Standard & Poor’s Ratings Services anticipates that historically low interest rates will support loan origination but remain an impediment to public agencies that develop affordable housing, especially single-family units.
Standard & Poor’s projects that the number of single-family housing starts will reach approximately 1 million in 2014, up from 530,000 in 2012, based on stronger employment. Our baseline projections for unemployment are 7.8% in 2013 and 7.3% in 2014, compared with the 8.07% actual rate in 2012. The increased income from higher employment translates to 3 million additional households, for a total of 125 million in 2014.
However, with a range of low short-term and long-term rates to compete with, housing finance agencies (HFAs), which aim to provide affordable housing, will continue to struggle to originate loans through mortgage revenue bonds. Because the economic recovery remains tepid, the Federal Reserve said on March 21 that it anticipated that unemployment would remain above 6.5% through 2014, in line with our projections. The Fed said that if these forecasts held true, it would keep short-term interest rates near zero. Furthermore, Standard & Poor’s projects that the 10-year Treasury note yield will reach no more than 2.61% in 2014. This historically low yield affects the 30-year mortgage rate, which Standard & Poor’s sees reaching 3.86% in 2014 in its baseline scenario.
Fannie Mae And Freddie Mac
We anticipate a continued strong role for government-supported entities (GSEs) even as we see greater activity in non-agency mortgage securitizations. Although the GSEs are seeking and evaluating different platforms for the participation of private capital, we believe that they are committed to supporting a recovering housing market. And despite the recent rise in home prices, a significant number of borrowers need modifications or other support to avoid foreclosure.
In particular, a recent approval from the Federal Housing Finance Agency (FHFA) will provide for streamlined loan modifications beginning this July for those loans backed by Fannie Mae and Freddie Mac. The modification program is designed to minimize administrative delays that may hamper the execution of a loan modification. The program, in our view, is further evidence of the agency’s support of a housing recovery. In addition, Home Affordable Refinance Program refinancings with loan-to-value ratios of more than 105% made up 43% of total refinancing volume in 2012 versus 11% in 2011. In terms of newer mortgage production, we see greater opportunities for GSEs to seek both credit risk transfer and also support private mortgage lenders through higher guarantee fees.
The FHFA has provided a representation and warranty framework to lenders that stipulates that all loans sold to Fannie Mae or Freddie Mac after Jan. 1, 2013 will relieve lenders of certain repurchase obligations for loans that meet specific payment requirements. For example, representation and warranty relief will be provided for loans with 36 consecutive months of on-time payments. Exceptions to these “sunset” provisions mainly relate to violations of state, federal, and local laws and regulations.
A Thaw In Private Capitalization
Greater clarity about lending practices emerged earlier this year. On Jan. 10, in accordance with the Dodd-Frank Act, the Consumer Finance Protection Bureau released a definition of qualified mortgages that limits upfront points and fees, bars specific loan features (such as interest-only and negative amortization), and caps debt-to-income ratios at 43%. On March 4, the FHFA announced its 2013 strategic plan scorecard, which calls for the execution of risk sharing transactions amounting to $30 billion unpaid principal balance of its current production. The strategy seems to coincide with the goal of contracting the significant presence of the GSEs in the marketplace. Accompanying this release in the same month was the release of loan performance data from Freddie Mac and a comment that Fannie Mae would soon follow with its release.
Concurrent with these actions, banks sought to clarify representations and warranties. We see two sides to the representation and warranty discussion. One side wants to ensure a commitment to solid underwriting and ensure alignment of interests through “skin in the game,” in which originators and aggregators are required to repurchase certain failed loans. The other side seeks to create a platform for strong third-party reviews of collateral as well as compliance with underwriting guidelines prior to securitization so that investors can evaluate loan quality. It is likely this debate will not be resolved while lenders are securitizing only the best loans. We believe these issues will resurface when certain borrowers who have FICO scores below the mid- to low 700s and can’t afford a 30%-35% down payment are once again able to get loans.
Overall, we believe that 2013 will see some meaningful shifts in the mortgage finance landscape. We are closely watching the development and finalization of risk retention rules, specifically the definition of qualified residential mortgages under Dodd-Frank.
Housing Finance Agencies
The biggest challenge for HFAs is loan origination as opposed to loan performance. State HFA single-family whole loan bond programs had an average delinquency rate (at least 60 days past due or in foreclosure) of 7.4% in the third quarter of 2012, the latest period for which data are available. This compares with 6.2% for state prime pools and 14.1% for state subprime pools. HFA loan performance has deteriorated somewhat since 2006, but has stabilized since 2010. We incorporate these delinquency rates into our loss assumptions, but in no instance has loan performance resulted in a negative rating action. And we do not anticipate that loan delinquency will trigger negative rating activity in 2013.
We do expect loan origination to remain challenging, at least in terms of bond programs. Competitive mortgage products and low interest rates have reduced the feasibility of financing loans through mortgage revenue bonds (MRBs). Instead many HFAs have implemented other loan origination techniques that do not rely on bonds. These include the sale of mortgage-backed securities (MBS) with Ginnie Mae guarantees to the “to be announced” (TBA) market, direct purchase loan participation pool sale to financial institutions, and whole loan sales to Fannie Mae or Freddie Mac. All of these examples differ from the traditional HFA model in that the HFA does not hold the loan after origination, thereby forgoing future revenue streams. In some cases HFAs have surpassed the origination levels they achieved with MRBs. The advantage to the alternative financing is keeping HFAs active in the financing business, although this comes at the loss of a stream of revenue. We believe that the benefits of non-traditional loan origination outweigh the downside and provide HFAs with diversification of revenue.
Although HFAs are the primary financiers of single-family housing in the municipal market, local issuers that included cities often used to finance loans through the tax-exempt market. That local issuers no longer significantly participate in the municipal housing market indicates the extent to which the industry has shrunk. We anticipate that the predominance of state housing agencies will continue for the near future.
Click here to read the full report.