Mortgage Lending in 2014 and Beyond: What Are the Drivers?

Jay Brinkmann* Chief Economist and SVP, Research & Education Mortgage Bankers Association
*Comments and opinions are solely those of the
presenter and do not necessarily represent official positions of the MBA or its members.

Five Major Drivers Impacting the Market

1) Higher severity costs will continue to lower acceptable default rates and thus tighten credit criteria. 2) Lending will be concentrated inside the CFPB safe harbor definition or go to FHA. 3) The cost of originating a mortgage will continue to go up. Which business models survive? 4) Banks will increasing weigh the legal and reputational risks of mortgage banking against reduced volumes and profitability. 5) The securitization and servicing models are being challenged by QRM and Basel III.

1) Causes of Higher Severity Costs

1) Regulatory requirements for how to deal with defaulted borrowers driving up servicing costs. 2) Lengthened legal timelines, particularly in judicial foreclosure states. 3) Zero-tolerance in buyback demands from GSEs and False Claims Act actions by FHA. 4) Liability under ability to repay provisions of QM for nonsafe harbor loans. Legal costs plus potential legal damages.
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Loans in the Process of Foreclosure by Judicial and Non-Judicial States

(Percent, NSA)

8.00 7.00 6.00 Judicial States

6.22 Difference

5.00
4.00

4.09 3.00 2.00 1.00 0.00

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2.13 Non-Judicial States

Source: MBA National Delinquency Survey

2) CFPBs Qualified Mortgage Rule

The ability to repay rule puts considerable potential liability on lenders who lend outside of the safe harbor guidelines. A successful lawsuit against a lender would likely cost in the range of $180,000 to $200,000. The legal defense expenses on unsuccessful suits would likely run in the range of $40,000. Per loan profits are in the range of $2,000, and will likely be lower in a lower volume environment. Is the risk of a non-safe harbor loan worth it?
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3) Loan Production Costs Going Up

Retail Apps per Underwriter per Month

250 Large Lenders Small Lenders

200

188 193 152

165

150

134

126 112 124

124 113

100

120 102

99

103 94 82
72

75 60 57

50

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

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Source: MBA/STRATMOR Peer Group Survey

4) Reputation Risk
What are the reputational risks for being in the mortgage business? What is the potential damage the value of the rest of the franchise?

Servicing complaints
Fair lending DOJ and HUD actions on disparate impact claims

2011 Data Show Net Exit from Business

Number of Institutions Reporting HMDA Data
9,000

8,500

8,000

7,500

7,000

6,500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: FFIEC

5) Basel III Risk Weights for Residential Mortgages

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Basel III Impact on Mortgages Held in Portfolio

Funding examples for 95 LTV mortgage with MI: Category 1 Mortgage Mortgage Funded with Deposits Equity Total cost Under Basel III: Funded with Deposits Equity Total cost Increase: Cost 2% 15% 3.04% 0.52% $ 100 Cost 2% 15% 2.52% Category 2 Mortgage Mortgage Funded with Deposits Equity Total cost Under Basel III: Funded with Deposits Equity Total cost Increase: Cost 2% 15% 4.08% 1.56%
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$ 100 Cost 2% 15% 2.52%

$ $

96 4

$ $

96 4

$ $

92 8

$ $

84 16

Impact of Basel III on Mortgage Servicing Rights

Basel III will make it very expensive for banks to hold mortgage servicing rights: MSRs more than 10% of Tier 1 capital must be deducted from equity. Given fluctuations in MSR values due to interest rates, the size of this deduction is unknown from quarter to quarter. Remaining MSRs carry a 250% risk weight.

MSRs plus most deferred tax items are limited to 15% of Tier 1 capital.
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Impact of Basel III on Banks with MSRs

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Conclusions
Higher severity costs are tightening credit and increasing operational costs and compliance complexity favor big banks and other large-scale operations, BUT Reputation and legal risk may cause them to pull back. Smaller independents have been better at originating purchase mortgages, BUT The regulatory complexities and potential QM liabilities and increased GSE & FHA fees point toward putting more loans into bank portfolios, BUT The increased Basel III capital requirements (and interest rate risk of long-term, fixed rate mortgages) make that expensive, particularly for riskier mortgages BUT Basel III requirements on MSRs and potential QRM retained risk requirements make securitization a problem, BUT ? 14