Compliance & Regulation

Freddie Mac lost $6.7 billion in the first quarter, and after accounting changes tied to guarantees issued on off-balance sheet instruments, saw its net worth plunge by $14.9 billion. With its net worth now clearly in the red (by $10.5 billion) the government controlled mortgage giant is asking the Treasury Department for $10.6 billion in aid. The government's policy is to keep both Freddie Mac and Fannie Mae in a positive net worth position, a move designed to assure investors that the bonds they issue are safe investments. The large drop in Freddie's net worth was caused by an accounting change that forced the company to add $1.5 trillion of assets and liabilities to its consolidated balance sheet, which in turn caused its net worth to plunge. (Fannie Mae, which soon will release its 1Q results, is facing a similar problem.) Although Freddie's loss and decline in net worth was indeed bad news, there were some positives in its report. The GSE established credit reserves of $5.4 billion in 1Q, down from $7 billion in the prior quarter. It also reported lower delinquencies on its single-family loans: 4.13% at March 31, compared to 4.2% at the end of February. Freddie's chief financial officer Ross Kari said its 1Q results "were driven significantly" by the Financial Accounting Standards Board-promulgated changes. He added that the firm is seeing some signs of "modest stabilization" in housing. If Treasury grants Freddie's request for new capital, the government's investment in the GSE will increase to $62.3 billion.

Senate leaders late Tuesday cleared the way for Sen. Olympia Snowe, R-Maine, to offer an amendment allowing mortgage bankers to originate residential loans to small business owners with flexible payment schedules that reflect seasonal changes in cash flows. The Snowe language would amend the Consumer Financial Protection Agency section of the financial services regulatory reform bill, putting such mortgages in a category where they will not be considered abusive by the new agency. "The bill does not take into account that many entrepreneurs use home mortgage loans with customized payment terms," Sen. Snowe said. (Until the credit crisis, some self employed workers used payment option ARMs, or "NINA" loans to obtain housing credit but those loans have since fallen out of favor and are now viewed warily by consumer groups and many elected officials as well as regulators.) Once Senate leaders reach an agreement to start the voting process, the Snowe amendment is expected to be adopted. Meanwhile, Senate Banking Committee chairman Christopher Dodd, D-Conn., reached an agreement with Sen. Richard Shelby, R- Ala., on the issue of bailing out large financial firms. "I'm satisfied we have reached an agreement on 'too big to fail,'" said Sen. Dodd, but noted that other senators want to see the final language before signing off on it. Dodd believes the agreement on the TBTF amendment will result in the voting process moving forward.

Sen. John McCain, R-Ariz., will offer an amendment to the financial services regulatory reform bill that weans Fannie Mae and Freddie Mac off government support over a five-year period. The amendment is modeled after a GSE bill crafted by Rep. Jeb Hensarling, R-Tex. Republican senators Richard Shelby (Ala.), Judd Gregg, (N.H.) and others are expected to support the amendment. Sen. Bob Corker, R-Tenn., noted that the Democrats' bill does not, in any way, deal with the future of the GSEs. (Fannie and Freddie were placed into conservatorship in the fall of 2008 and, to date, have received more than $100 billion in capital assistance from the Treasury.) The Hensarling approach terminates the conservatorships after two years. If the GSEs are viable, they will be given a three-year transition period to reduce their huge mortgage portfolios and go private. The McCain amendment would not proscribe a "solution" for Fannie and Freddie, Sen. Corker said. But "it puts in place a process to absolutely make sure something happens," he said. Republicans have been critical of the Obama administration for providing unlimited taxpayer support for the GSEs and not advancing a plan sooner to deal with the mortgage giants.

Large banks have repeatedly prevailed in battles to preserve federal preemption in Congress and the courts, but that victory string is likely to be broken by the regulatory reform bill being debated in the Senate this week. With so many other provisions requiring the large banks' attention, such as a crackdown on derivatives and a ban on proprietary trading, most of them will lack the time or attention to fight curbs on federal preemption. Without their help, the Office of the Comptroller of the Currency, which has been quietly pushing for changes in the bill, is not expected to prevail. "The large banks are playing more defense than they thought they would," said Raj Date, the chairman and executive director of the Cambridge Winter Center for Financial Institutions Policy. "That means the OCC won't have as much help from its national-bank allies." Though the Senate bill would not eliminate preemption, it would force the OCC to jump through several legal hoops before declaring that national banks need not comply with a state law. These include proving that an existing federal regulation sufficiently addresses the issue a state was trying to rectify. Under other circumstances, this would probably be a top priority of the industry's trade groups and the largest banks. But they are focused on other parts of the bill they view as more important, including the so-called Volcker Rule, which would ban proprietary trading, and provisions to regulate derivatives.

Most banks did not tighten lending standards on prime or nontraditional single-family mortgages during the past three months and there appears to have been some relief on HELOC standards, according a new survey of senior loan officers conducted by the Federal Reserve. Nearly 80% of banks surveyed said their lending standards were unchanged from January. On prime mortgages, only 11% said they tightened credit with the balance saying they eased. "Large bank respondents eased standards on balance, for both prime mortgages and home equity lending lines of credit," the Fed said. However, loan officers told the central bank that demand for residential mortgage loans weakened over the past three months. As for commercial real estate lending, some banks continued to tighten underwriting, but demand for CRE is now showing signs of stabilizing, the survey found. For the first time since the financial crisis began, less than 10% of the respondent banks reported weaker demand for CRE loans, the Fed said. Over 45% of banks reported increased use of loan extensions on existing CRE loans over the past six months.

The Obama administration's bank tax proposal could curtail borrowings from the Federal Home Loan Bank system by large depositories and reduce mortgage liquidity for member institutions, according to the American Bankers Association. The administration's proposal would impose a tax on financial institutions with more than $50 billion in assets --but only for firms that were eligible for emergency assistance programs such as the Troubled Asset Relief Program. ABA chief economist James Chessen told the Senate Finance Committee the 15 basis point tax on non-deposit liabilities (including FHLBank advances) would increase the costs of large banks borrowing from the system, and reduce demand for FHLB advances. This has "important implications for the financial stability" of the 12 regional banks and "could lead to a downward spiral" with fewer advances being made, he warned. The trade group is concerned that members will reduce their holdings of the FHLB stock required to borrow, thus shrinking the system and its ability to provide liquidity to all members. Treasury secretary Timothy Geithner said the bank tax could raise $117 billion over 10 years to cover the government's cost of the financial crisis. He stressed the tax will not affect 99% of depository institutions.

A risk analysis firm said it is helping mortgage professionals access tax return amendment data that more common industry tax form verification efforts do not include in order to head off a growing fraud concern. The National Credit-Reporting System Inc. (NCS)/Credit Central, Egg Harbor, NJ, said it has added to its report that summarizes tax return transcripts a summary of the IRS's Record of Account transcript. The IRS Tax Return Transcript more commonly used by the industry does not provide information on amendments to returns, said Cecil Bowman, an NCS senior vice president and former IRS senior manager. The company instead recommends data from the Record of Account transcript that does include this information along with taxpayer identification number verification.

A quarterly survey by two Chicago professors shows a dramatic increase in the number of "strategic defaults" where an underwater homeowner willingly defaults on his mortgage even though he can afford to make the payments. An estimated 31% of foreclosures involved strategic defaults in March, compared to 22% a year ago, according to the Chicago Booth/Kellogg School Financial Trust Index. The survey is conducted by professors Paolo Sapienza of the Kellogg School of Management, and Luigi Zingales of the University of Chicago Booth School of Business. They said the likelihood of strategic default increases by 23% if a homeowner discovers that a neighbor with negative equity received loan forgiveness from their servicer. The likelihood increases to 29% if homeowners can find alternative financing for a new home. The survey found that 56% of homeowners do not believe that lenders will come after them if they walk away from their home. "With more and more homeowners believing that lenders are failing to pursue those who default on their mortgage, there is a risk that a growing number of homeowners will walk away from their homes even if they can afford the payments," Sapienza said.

The Rural Housing Service has enough remaining loan commitment authority to continue guaranteeing single-family loans through May 6, according to the Department of Agriculture. "We anticipate funding likely will be exhausted by May 7," the agency said. It was understood RHS would run out of loan authority on April 30 and the House quickly passed a bill (H.R. 5017) last Tuesday to extend the program through Sept. 30. Sen. Michael Bennett, D-Colo., has introduced a similar bill, but the Senate adjourned on Friday without passing it. The Senate resumes legislative activities on Monday. "Depending upon Congressional activity with the proposed legislation, it is possible that the agency may consider issuing conditional commitments," RHS said. The House-passed bill makes the RHS single-family program self-funding by raising the 2% upfront guarantee fee to 4%. RHS is expected to set the fee at 3.44%. The increase means Congress will not need to approve additional funding to keep the RHS guarantee program running.

The 12 Federal Home Loan Banks reported combined earnings of $345 million in the first quarter, a 6% decline from the same period last year. However, some of the regional banks that were suffering from losses on private-label securities moved into the black with stronger FHLBs reporting reduced profits due to a variety of reasons. The PLS-encumbered banks of Chicago, Seattle and Pittsburgh reported earnings of $1 million, $6 million and $10 million, respectively, compared to losses a year ago. They benefited from a big decline in credit-related charges on private-label mortgage-backed securities. Systemwide, the 12 banks took credit-related "other than temporarily impaired" charges of $233 million in the first quarter, down 55% from the same period in 2009. Meanwhile, stalwart GSEs like the New York and Cincinnati FHLBs reported a decline in profits. The New York bank posted $53.6 million in earnings, down 64% from the first quarter of 2009. The bank attributed the performance to a 15% decline in advances from record levels a year ago and higher borrowing costs. The Cincinnati bank said earnings came in at $43 million, down 48% from a year ago. The FHLB bank cited "extremely wide spreads between Libor and short-term consolidated discount notes" and other factors for the decline. "The first quarter of 2010's earnings were more normal relative to historical experience," the Cincinnati bank said. The 12 FHLBs combined have $966 billion in assets.