Compliance & Regulation

House and Senate conferees shaping the final regulatory reform bill tentatively accepted an amendment by Rep. Scott Garrett, R-N.J., that would create a new legal and regulatory framework for the development of a covered bond market in the United States. Bank issuance of covered bonds backed by residential and commercial mortgages is more common in Europe. Foreign banks service and keep the mortgages on their books in a manner unlike the mortgage-backed securities used more commonly in U.S. where the underlying mortgages have traditionally been placed in separate, off-balance-sheet trusts. "Covered bond legislation offers a way for the government to provide some certainty for private enterprises to find a way to generate liquidity through innovation of a new marketplace," Rep. Garrett said. The New Jersey congressman also stressed that covered bonds would open the door for lenders to originate mortgages that are not guaranteed by the government. Under the Garrett amendment, the Treasury Department would be the primary regulator of covered bonds, and set standards and reporting requirements for issuers. But for the market to move forward, the Federal Deposit Insurance Corp. must continue its policy of not seizing mortgages that are backing covered bonds when the sponsor bank fails. House Financial Services Committee chairman Barney Frank, D-Mass., noted that Treasury and FDIC officials have raised some questions about the covered bond proposal. Rep. Frank said the conferees would not formally approve the Garrett amendment until Thursday, giving regulators time to refine their concerns and "tell us what they are," Frank said. Sen. Bob Corker, R-Tenn., was prepared to offer a similar covered bond amendment on the Senate side but House members offered their amendments to the regulatory reform bill first.

Treasury secretary Timothy Geithner early next year plans to present a proposal for "fundamental reform" of Fannie Mae and Freddie Mac along with other facets of the housing finance system. He told a TARP Congressional oversight panel that Treasury officials are examining options for restructuring the GSEs which have been in conservatorship for almost 20 months and could wind up costing taxpayers $400 billion. Together, the two account for about 70% of all originations in the nation. FHA accounts for most of the balance with portfolio lending (mostly jumbo) making up a sliver of all originations. The secretary said the agency will not stop with its study of Fannie and Freddie. "The range of things that contributed to this mess went well beyond the basic incentive problems and moral hazard problems that prevailed at the GSEs," he said. He told the Troubled Asset Relief Program panel that today Fannie and Freddie are being managed more conservatively. "At our insistence, they have put in place much more conservative underwriting standards. They are charging more for their guarantees to remedy some of the mistakes they made earlier," he said.

The Federal Deposit Insurance Corp. is receiving higher bids for failed bank assets and officials at the agency say they are beginning to see signs of a recovery in the financial services industry. In a new memo, the agency notes that it is seeing "more bidders and higher bids" for failed institutions. "Not only are failed insured-depository institutions with good deposit franchises attracting better prices, but there have also been higher-than-expected proceeds from assets sales." In 2009, regulators closed 140 insolvent banks and thrifts. So far this year, there have been 83 bank failures. "We still expect bank failures to peak this year, and start tapering off next year as the industry continues to heal and recover," FDIC chairman Sheila Bair said at a Tuesday FDIC board meeting. The FDIC staff memo highlights several indicators showing the banking industry is starting to recover. More than half of all FDIC-insured institutions were profitable in the first quarter. Banks are reporting lower new loan loss provisions and net charge-offs have declined for the past four quarters. In addition, the number of institutions on FDIC's problem bank listed increased by only 10% in the first quarter to 775. In the previous quarter the number of problems bank jumped 27% to 702. "(S)igns of a slowdown in the growth of this number are a positive indicator that the industry could be slowly improving," the memo says.

The House has passed a stand-alone bill to re-authorize the National Flood Insurance Program, which has not been able to issue new policies for the past three weeks. The bill (H.R. 5569) extends the NFIP until Sept. 30 and makes the re-authorization retroactive to May 31 when the Federal Emergency Management Agency had to stop issuing new flood insurance policies. "This is the third time this year that the flood insurance program has expired, causing disruption in the housing market in cases where individuals are trying to purchase a home located in a flood plain," said Rep. Gary Miller, R-Calif. The House passed the September extension Wednesday morning by a voice vote. The National Association of Realtors and other housing groups want the Senate to act quickly. The Senate is currently deadlocked over a $100 billion jobs bill passed by the House several weeks ago that includes an extension of the flood insurance program.

House Financial Services Committee chairman Barney Frank, D-Mass., is asking Senate conferees to drop a "qualified" mortgage exemption that would allow nongovernment loans to be securitized without risk retention. In reconciling the House and Senate financial services regulatory reform bills, Rep. Frank is offering to totally exempt Federal Housing Administration, Department of Veterans Affairs, and Rural Housing Service guaranteed loans from a 5% risk retention requirement for MBS issuers. However, issuers of Fannie Mae and Freddie Mac MBS would have to retain 5% of the credit risk under the Frank proposal. "It would create a huge imbalance in the marketplace in favor of FHA and VA loans," said Glen Corso, managing director of the Community Mortgage Banking Project. Mortgage industry groups prefer a Senate-passed provision that would allow regulators to totally exempt safe, fully documented mortgages from risk retention, which presumably would encompass Fannie/Freddie loans. Industry groups claim qualified mortgages that are exempt from risk retention and shielded from liability could lead to a revival of the private mortgage market. "The lack of a true safe harbor for following federally mandated minimum standards for a qualified mortgage will result in lenders and investors establishing even tighter credit standards than those called for in the qualified mortgage or avoiding residential mortgage investments altogether because of the potential for excessive legal risks," the joint letter says. House and Senate conferees are in meetings, trying to work out differences on such mortgage related issues as yield spread premiums, appraisals, underwriting standards, risk retention, and the creation of a consumer protection agency.

Fannie Mae and Freddie Mac are increasing their use of short sales which is considered a better alternative for lenders and homeowners than a foreclosure sale, according to a report by their regulator. The Federal Housing Finance Agency says the two government sponsored enterprises completed 23,400 short sales in the first quarter, compared to just 8,050 a year ago. GSE servicers are expected to implement a new 'Home Affordable Foreclosure Alternative' program by August 1 that places more emphasis on short sales as an alternative to foreclosure. Fannie and Freddie completed 92,760 foreclosure sales in the first quarter, up 27% from the previous quarter. Short sales allow the homeowner to walk away from their house debt free and generally results in a higher sales price and less expenses than a foreclosure or REO. An Amherst Securities Group report shows that short sales have a significantly lower loss severity than REO sales, "but that difference has been narrowing over time." ASG analysts note that servicers are becoming more proficient at short sales. However, the loan-to-value ratios on short sales have been increasing relative to REO sales. And the amount of servicer advances has increased more for short sales than for foreclosures. "We believe the narrowing between short sale and REO sale is largely complete," Amherst says.

The Federal Reserve Board and the other banking regulators finalized guidance governing executive compensation practices on Monday and announced its review of pay at the largest holding companies had turned up significant flaws. The final guidance is similar to what the central bank proposed in October, but would now apply to the entire banking industry. Previously, its efforts targeted only holding companies and state-member banks. But the other three banking agencies have now signed on to the guidance, which explicitly says it is applicable to all institutions and their holding companies. The guidance also makes some concessions to smaller banks, who had complained in comment letters that they did not pay the exorbitant bonuses that helped lead to the financial crisis and should be shielded from the proposed regulations. The final guidance does not exempt community banks, but more clearly defines regulators' different expectations for large and small firms. "The final guidance makes more explicit the view that the monitoring methods and processes used by a banking organization should be commensurate with size and complexity of the organization, as well as its use of incentive compensation," the guidance says. "In addition, the final guidance highlights the types of policies, procedures, systems and specific aspects of corporate governance that [large banking organizations] should have and maintain, but that are not expected of other banking organizations." Additionally, the final guidance requires large banks to follow certain steps. For example, large banking companies must form a compensation committee that reports to the board of directors. The board is also required to directly approve compensation arrangements of senior executives, including clawback provisions. The guidance also directs large banks to consider how golden parachutes and similar arrangements affect risk and employee behavior. Large banks are also required to actively monitor industry, academic and regulatory developments in incentive compensation and be prepared to incorporate those into their systems. Those requirements were not extended to smaller institutions.

Federal Deposit Insurance Corp. chairman Sheila Bair is warning against indefinite government control of Fannie Mae and Freddie Mac. In a recent speech on housing policy, Bair said some government involvement in mortgage finance is "certainly justified." But the nation's financial crisis, which included the 2008 seizure of the GSEs by their regulator and the Treasury (to prevent their collapse) proved "any such program must be much more definitive about where the financial obligation of taxpayers begins and ends," she said. In prepared remarks at the Wharton School's International Housing Finance Program, she noted that "there are a variety of options for making some of their functions governmental while putting others in private hands." The FDIC chief said policymakers should address the government's role with the enterprises after financial regulatory reform is finished. "After the financial reform package becomes law, GSE reform should rise to the top of the agenda," Bair said. "The goal must be to clarify once and for all which functions should be governmental, and which are strictly subject to the discipline of the marketplace."

Almost half of all distressed homeowners who did not qualify for a permanent HAMP loan modification have received assistance through alternative or proprietary modification programs offered by private servicers, according to new figures released by the Obama Administration. Housing and Urban Development secretary Shawn Donovan said only 11% of borrowers in the Home Affordable Modification Program payment trials have fallen into foreclosure or lost their homes through a short sale. "It is a clear indication that the efforts of HAMP, combined with other efforts, are having a substantial effect," the HUD secretary told reporters on Monday. Another 26% of the 277,600 borrowers that dropped out of HAMP trials (as of April 30) are still being evaluated by servicers for a proprietary modification. (As of May 30, 429,700 borrowers had dropped out of HAMP trials.) The secretary also noted that 2.8 million borrowers have received restructured mortgages through HAMP, Federal Housing Administration and proprietary programs during the 12-month period ending April 30. "This is nearly three times the number of foreclosures completed during this same period," secretary Donovan said.

The National Credit Union Administration approved a $1 billion charge Thursday to pay for the corporate credit union bailout. The corporate assessment comes after last year's charge of $1.1 billion, which included $337 million for the first year of the corporate bailout and the remainder to replenish reserves for the National Credit Union Share Insurance Fund. This year's corporate assessment amounts to 13.4 basis points and must be accrued by credit unions for the second quarter, and paid by Aug. 30. The corporate assessment is expected to drive as many as 1,068 credit unions into the red for the second quarter and as many as 552 into the red for the year, while pushing about 60 credit unions into undercapitalized territory, according to NCUA. Almost half of the nation's 7,800 credit unions, 49.5%, reported losses for fiscal 2009, many of them because of the NCUA assessments.