4.18.2007

Fannie/Freddie to rescue the "Lending Crisis" (?)

Yahoo News yesterday reported that FannieMae and FreddieMac are stepping up and proposing to make some changes to the subprime loans they are holding.

For those who need it, a little background:

Fannie Mae, and Freddie Mac are acronyms for large corporations that are generally sponsored by the federal government to provide stability in the mortgage lending marketplace. They were originally started in the early part of the 20th century as wholly owned government agencies designed to provide affordable home loans for returning servicemen, etc.

They've since been privatized but retain a government sponsorship, in order for the government to have a modicum of control over the nation's lending practices.

Both companies are MASSIVE secondary-market purchasers of already-originated mortgage loans, competing with the other typical Wall Street buyers in that marketplace. Fannie Mae has been beset with management problems and financial reporting errors in the recent past, but they remain a huge purchaser of loans that meet certain criteria.

(Fannie Mae, just this week has entered an agreement to be purchased by, you guessed it, a private equity firm who has garnered a coalition of groups, two of whom are CITI Bank, and Chase bank. The equity fund will retain majority control, while the two banks will have a minority interest. The group says it will continue to report publicly, and seeks to retain the government sponsorship, helping it retain its power and stability in the marketplace.)

Fannie Mae owns and services a large percentage of the subprime loans in the US right now. There is a morass of foreclosure looming on the not-too-distant horizon for the borrowers in this type of loan.

Typically they are called "2/28's" which means that the loan has an amortization of 30 years, and a fixed period of only two years on the front of the loan. The remainder of the loan is adjustable, according to the lenders program at the time of closing. The amount of adjustment depends upon the "caps" that were in place at the time of closing.

Most caps are typically expressed as a three-number combination that most people fail to understand, usually 6-2-6. The first number represents the amount of increased interest rate the lender is allowed to charge upon the first opportunity, the 25th month of the loan. If you have a loan at 7% on a 2/28, and your caps are 626, that means that in the 24th month your interest rate is 7%, and in the 25th month, your rate can be legally moved to 13% under this program. The second number in the combination, (2) represents the number of adjustments per year the lender is allowed to make to your loan - i.e. every six months. The third number (6) is the lifetime cap on interest rate rise for the life of the loan. This is the "safety net". Under this program, the interest rate may NEVER go above the 7% (original rate) plus 6% (the cap number), in this case 13%.

You can imagine how distressing this type of loan would be to a person who borrowed 100% of their home's value in order to get the purchase done. They have NO equity. When the loan gets ready to adjust that first painful time, they have no ability to get a refinance done, especially if home prices are in a general state of decline - which they are right now, nationally. They are poor-credit borrowers in the first place, and have no savings, no extra income, and negative home equity from which to borrow.

The borrower becomes stuck in a loan they can't get out of, with the possibility of it adjusting WILDLY at the 25th month.

Sucks to be them. Anecdotally, 900 Californians PER WEEK are losing their homes to foreclosure right now, due to this very problem. Per week.

So, as you can imagine, this situation has the industry on its ear, and everybody in a regulatory position is seeking ways to mitigate the massive losses. You've heard about lenders like New Century, Novastar, etc... the list is LONG, of lenders in trouble for having originated these types of loans, and now the Wall Street buyers are asking the lenders to buy them back, because they aren't performing. This is how lenders go out of business.

Congress is hurrying to weigh in the situation, and the Banking Committees of both houses are holding hearings to see if there is something they can do. (I hope they stay out of it, and wait for the industry to self-regulate, because they don't even understand what an "exotic hybrid mortgage" is... they will make a mess, mark my words...)

So before lawmakers can wade into the fray, the industry's biggest players are taking steps to make things better. Fannie is proposing to make adjustments to these loans for deserving borrowers. They are offering to fix the caps issue related to that first nasty adjustment, and they are also going to move the amortization out to 40 years, instead of 30 years. This will have the effect of lowering the borrower's PAYMENT by up to five percent per month. Not the interest rate, but the payment.

Sounds like a pretty good deal to me, and just in time, before lawmakers can make a lovely mess of things. It's always best to let a free market regulate and correct itself - after all, they still need to lend money, and the money still needs to perform, or the owner of the money goes out of business - that's the best motivator for change there is. Lawmaker posturing and puffing is useless, and will only have a detrimental effect on the situation.

8 comments:

OneHungMan said...

You're a genius, and OneHung is, well, let's just say it's a good thing he's got three legs. He refinanced the house he lives in five years and some change ago. The loan has been sold twice in those five-plus years.

What's the benefit for a lending institution to sell a loan/buy a loan?

That One Guy said...

You ask two questions:
First - what is the benefit of a mortgage holder to SELL a loan?
Answer: Typically, those who actually originate the mortgage loan are small companies, with limited cash on hand, maybe up to 20 million. (that's about enough to originate 100-150 mortgage loans. If I am a lender who is holding a performing loan, I have interest income on the payments every month - but I have also tied up a certain amount of that capital that I can't use for something else, like originating other loans. If I want my capital back, I can choose to sell the loan. Why would I do that? When I put it up for sale, I'll get anywhere between 103% and 107% of the face value of the note, because it is performing and the new owner can count on the interest income, for which he will pay a premium. Additionally, I will then free up my capital funds to do something else, like originate another loan which I can sell again for 103-107% of its face value. It's a profit game - and when I sell, I negate the risk that at some point in the future, the loan may not perform, and I would have to foreclose on the property, making me a property owner, rather than a money owner. Lenders HATE to own property. With a passion. So much so that a lender can be forced to sell a loan for less than 100 cents on the dollar, just to get out of it - that's called a short sale. It's the GET ME OUT OF THIS DAMN LOAN scenario.

Second question: benefit for a lending institution for BUYING a loan:

Loans are bought and sold every day, as a major part of the bond market. Didn't used to be so, but it is today. If I am a big lender, looking to buy loans on the open market, I am going to talk to the smaller lenders, like above, who have loans to sell, and tell them what types of loans I am looking for, and what I am willing to pay for them.

For example, I might put out a specific scenario like this:

--80% financing only - I must have 20% equity in EACH property.
--680 credit score and above only.
--FULL doc only - no stated income
--No ARM products, 30 year fixed loans only
--Primary residences ONLY, no investment properties.

If you put a pool of $500,000,000 of these loans together for me, I will pay you 105% of their face value.

The lender will do this because these loans perform, and in the odd instance that one doesn't perform, the lender is protected by his 20% equity, so if he has to short sell it to get out, he can still maybe make a small profit on the sale, because he only owes 80% of its actual value.

The lender will pay the premium because he is banking on a steady stream of income over the years from these loans. Think about it this way: the lender pays a one-time premium of 5% in the scenario above, for a loan that has in ANNUAL interest rate of perhaps 6.5%. That means in the first year of his investment in the loan, he makes 1.5% (the difference between the premium he pays, and the note interest rate on the loan he bought), BUT the following year, and every year AFTER that, he makes the full 6.5% interest on his investment.

That's good money for a money fund, a REIT, a retirement fund manager, etc. Good solid returns on your money.

Hopefully that made sense to you.

OneHungMan said...

Yes, made perfect sense, now OneHung can stop wondering why he writes checks to different lenders all the time (rental house loan has been sold numerous times as well).

ragdelaed said...

where did you hear that fanniemae was getting bought out?

That One Guy said...

ACTUALLY, I REALIZED THIS MISTAKE IN THE MIDDLE OF THE NIGHT LAST NIGHT... IT'S ACTUALLY SALLIE MAE, THE STUDENT LOAN COMPANY WITH GOVERNMENT SPONSORSHIP THAT HAS ENTERED THE AGREEMENT TO BE ACQUIRED...

THANKS FOR THE CALL-OUT ON THAT ONE, I STAND CORRECTED.

AND THANKS FOR READING, WHOEVER YOU ARE.

Reach Upward said...

Our first home was in a subdivision of tiny starter homes that was built when interest rates were in the stratosphere back in the late-70s to early-80s. We came onto the scene a few years later when interest rates had gone down substantially.

It was amazing to see the number of foreclosures in the neighborhood. We picked up our home at a good price from a distressed seller.

A number of homeowners in the subdivision were marginal buyers (higher risk debtors) who had financed on ARMs that subsidized low rates in the first two years for higher (often fixed) rates for 28 years. When interest rates plummeted, these folks couldn't refinance to take advantage of it because they had missed payments and were higher risks than when they went into the loans.

It was nasty. Lots of these people lost their homes. Many declared bankruptcy. Many of those homes sat vacant for months (sometimes for over a year) and fell into disrepair before they were finally sold to new buyers (at very low prices). I assume that the lenders took a beating on many of those sales. So everyone lost out except for the new buyers.

Although some elements of today's situation differ, it is sad to see the cycle repeating itself.

That One Guy said...

Re: CAPS... note also that sometimes, depending on the lender, that middle number in the 626 example, the "2" represents the percentage amount that the rate on the loan can be raised each time after the initial adjustment takes place (the "6")

It just depends on the lender.

That One Guy said...

Reach - this cycle is a never-stopping pendulum. It is always moving in either one direction or another. The swing is usually 7-8 years. We are in the second full year of the pendulum moving rates up and values down. Sometimes the Rate/Value swings aren't correlated, and when that happens, you have a perfect storm of trouble for people who have no oars. Like right now.

It's a greed thing. We don't learn - we always want more. What a great country. :)