Compliance & Regulation

"Exotic" mortgages -- in particular, payment-option ARMs and interest-only loans -- were a factor in the nation's housing boom of the past few years, a panel of economists told a Senate subcommittee on Wednesday.Richard A. Brown, chief economist of the Federal Deposit Insurance Corp., told the Senate Banking subcommittee on housing that in "hot housing markets" payment-option adjustable-rate mortgages and IO loans were used to help qualify homebuyers. Mr. Brown and other panelists said exotic loans and other factors -- including low interest rates, market demand, lack of developable land, and rising commodity prices -- fueled a home price boom that began in 2003. David Seiders, chief economist for the National Association of Home Builders, said the performance of option ARMs and IO loans is an "area of substantial uncertainty" for the market. He said "we know the dollar volume" of option ARMs originated, but "we don't know the features. Is it a payment-option ARM with a piggyback loan too?" Some economists believe that when option ARMs adjust at higher note rates, many consumers may default on the loans. Next week the subcommittee will hold a hearing on the role exotics play in the mortgage market.

The risk that mortgage fraud will have a harmful economic impact in vulnerable markets is rising at an "unprecedented" rate, according to CoreLogic, a Sacramento, Calif.-based provider of fraud prevention technology and services to the mortgage industry.CoreLogic reported that its Core Mortgage Risk Monitor rose 5% in the second quarter after increasing 6.4% in the first quarter. The five major metropolitan statistical areas most at risk, according to the index, are Detroit-Livonia-Dearborn, Mich.; Memphis, Tenn.-Miss.-Ark.; Dayton, Ohio; Akron, Ohio; and Gary, Ind. The index measures collateral risk, which is "the risk associated with the accuracy of a residential property valuation and the sustainability of that valuation over the life of the mortgage due to the unique characteristics of the property, market, and mortgage contract participants," CoreLogic said. The company can be found on the Web at http://www.corelogic.com.

PNC Financial Services, Pittsburgh, is rebalancing its portfolio and says it expects to sell $6 billion in securities, booking a $200 million loss on the deal.PNC disclosed the information in a recent 8-K filing with the Securities and Exchange Commission. Some news reports said the securities in question are collateralized by mortgages, but the word "mortgage" is not used in the 8-K filing. PNC could not be reached for comment by MortgageWire's deadline. In the filing, the bank said the securities "will likely underperform on a relative-value basis."

Freddie Mac says it believes that the government's criminal investigation of its accounting scandal is now inactive, issuing a statement that "we expect no further action in this matter."A spokesman for the U.S. attorney in Northern Virginia had no comment on the matter. A Freddie spokesman noted that the government typically does not comment on the status of its investigations. However, at the end of August, the U.S. attorney's office for the District of Columbia confirmed that it had discontinued its criminal investigation of Fannie Mae and will not bring any charges against the company. Freddie's accounting scandal broke into the open in June 2003 when the company fired its two top officers. Eventually, the government-sponsored enterprise restated prior earnings upward by $5 billion. Fannie Mae is facing a downward earnings restatement of $10.6 billion. Neither GSE is current on its earnings statements.

The first enforcement actions relating to investigations into the pricing of 2004 subprime loans could be announced in the next three to six months, according to industry attorney Andrew Sandler."I would expect over the course of the next three to six months there will be at least several consent decrees or lawsuits by federal enforcement agencies and/or state attorneys general involving mortgage loan pricing that reflect the conclusion of investigations related to 2004 HMDA data," Mr. Sandler told MortgageWire. The release of 2004 Home Mortgage Disclosure Act loan pricing data last year initiated investigations and special exams of nearly 200 banks and mortgage companies for possible discriminatory pricing practices. Investigations by the Department of Justice, the Federal Trade Commission, the Department of Housing and Urban Development, federal banking regulators, and state AGs can take up to two years. Mr. Sandler, a partner in the Washington office of Skadden Arps, indicated that additional enforcement actions are possible. Based on the newly released 2005 HMDA data, the Federal Reserve Board referred 270 lenders to their primary regulators for further fair-lending reviews. A Fed spokeswoman said there is a lot of overlap between lenders on the 2004 list and the 270 lenders on the 2005 list.

Newly released Home Mortgage Disclosure Act data show a big increase in subprime lending in 2005, and regulators are pointing to a jump in piggyback loans as one reason.More than one-half of all African-American borrowers purchasing a home in 2005 paid subprime interest rates, compared with 17.2% of whites, according to HMDA. It shows that 54.7% of blacks and 46.1% of Hispanics received subprime loans to buy a home -- a dramatic jump from 2004 results, when 32.4% of blacks and 20.3% of Hispanics received subprime purchase loans. Earlier this year, Federal Reserve Board officials warned that the flattening of the yield curve would increase the number of HMDA-reported loans with subprime rates, defined as 300 basis points or more above the rates of comparable Treasury securities. However, Fed researchers concluded that the yield-curve effect was not that large. A bigger factor was the 57% increase in piggyback loans from 2004 to 2005. "[T]he increase in the number of high-priced piggy-back loans in 2005 accounted for more than half of the increase in the number of all higher-priced loans," the Fed says in its analysis of the HMDA data.

Housing sales and construction activity declined in July and August while demand for mortgage loans weakened, according to the Federal Reserve Board's newly released Beige Book."In general, residential real estate contacts expected the housing markets would remain weak, if not weaken further, in the months ahead," the Beige Book says. In the June Beige Book, the Federal Reserve district banks noted that housing markets continued to "cool." But the references to cooling have been replaced by reports of "substantial increases" in unsold homes. The Kansas City bank attributed some of the increase in inventories to a "sizable number of foreclosures." The Atlanta bank reported that the property insurance premiums in some parts of Florida have nearly quadrupled in the past year, and this is "adversely impacting housing and commercial real estate demand in the coastal markets." Meanwhile, commercial real estate markets remained strong in many parts of the United States, and many Federal Reserve banks reported increases in CRE development and construction.

More than one-half of all African-American borrowers received conventional subprime mortgages in 2005, according to a Consumer Federation of America study, which analyzed a sample of the 2005 Home Mortgage Disclosure Act data.The Federal Reserve Board is expected to issue its annual report and analysis of the 2005 HMDA data soon. The CFA study found that 53.0% of African-American borrowers and 37.8% of Latino borrowers received conventional subprime loans, which (according to the HMDA data) have an interest rate of more than 300 basis points above comparable Treasury securities. Looking solely at refinancings, the CFA found that subprime refis increased from 14.7% of all HMDA-reported loans in 2004 to 26.5% in 2005. Over the same period, refinanced loans priced at more than 500 bps above Treasury securities doubled from 4.2% to 8.8%. Earlier this year, regulators at the Fed cautioned industry and consumer groups to expect a substantial jump in the number of HMDA-classified subprime loans because of the flattening of the yield curve during 2005.

The Federal Housing Finance Board is considering changes to its capital proposal that would make it less onerous and difficult for the Federal Home Loan Banks to come into compliance with new retained earnings requirements."Some commentators made valid points [in comment letters]," FHFB Chairman Ronald Rosenfeld told a congressional panel. "There is room for movement on several important issues." Since the 12 FHLBanks are well capitalized, many questioned the need for a 50% dividend payout limit while the FHLBanks raise their retained earnings to meet the proposed minimum requirement of $50 million plus 1% of non-advance assets. "That is a constructive observation, and we should consider a higher dividend payout ratio, which would extend the time for the FHLBanks to reach the retained earnings minimum," Mr. Rosenfeld said. Many members of the House Finance Services Committee urged the FHFB chairman to withdraw the proposed rule, contending that it would harm the FHLBanks and their affordable housing programs. But Mr. Rosenfeld did not give any indication that he would back down.

President Bush has nominated former Goldman Sachs vice chairman Robert K. Steel to oversee domestic finance and government-sponsored enterprise matters at the Treasury Department.Mr. Steel would replace Treasury Under Secretary Randal Quarles, who announced earlier this summer his plans to step down when Congress adjourns for the year. The nomination comes at a time when Treasury Secretary Henry Paulson is trying to encourage senators to find a legislative solution to the stalemate over a GSE regulatory reform bill that would force Fannie Mae and Freddie Mac to reduce or limit the size of their giant mortgage portfolios. Mr. Steel worked at the Goldman Sachs Group with Mr. Paulson, who was the chairman and chief executive. The nominee is a senior fellow at the John F. Kennedy School of Government at Harvard University.