TheMReport — News and strategies for the evolving mortgage marketplace.
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COVER STORY today—90 percent of new mort- gages are government-backed— banks are setting aside loan loss reserves for repurchases of bad paper from investors, mainly the GSEs. "Repurchases from Fannie and Freddie now seem to be the No. 1 risk factor" among major lenders, CrewsCutts says. Seen in that light, banks are exercising common sense and prudence: Slightly higher under- writing standards translate to for only about half as many Americans—4.1 percent. And 46.6 percent of consumers' credit scores stayed relatively flat over that three-year period. So even though prime mortgage supply and demand is rising modestly, the majority of potential bor- rowers still fall in the subprime categories, and lenders still view that range as toxic (to use a loaded term). Banks could be forgiven, then, for assuming that If the risk experts' instincts are right, that means responsible borrowers currently in the market shouldn't expect a loosening of credit anytime soon; more defaults in the lenders' rearview mirror mean more repurchases and capi- tal writedowns, which mean less liquid supply for future lending, even if the demand snaps back. Compounding their image problem, some banks are hedg- ing their repurchase and default More defaults in the lenders' rearview mirror mean more repurchases and capital writedowns, which mean less liquid supply for future lending, even if the demand snaps back. significantly lower risks. When looking at 60-day delinquencies in late 2011, FICO found that borrow- ers with scores of 670 ran odds of default that were two-and-a-half times higher than borrowers in the 710 range. Originators know that already: That's why, according to the same study, 13 percent more of their overall lending in 2011 was to borrowers with a FICO over 700, when compared with 2005 lending levels. Even more interesting, the FICO report found that 7.3 percent of American consumers qualified as "fallen angels"— borrowers whose FICO score dropped 100 points or more between 2008 and 2011. "Rising stars," whose FICO score rose 100 points or more, accounted 24 | THE M REPORT mortgage risk has grown, and standards should stay tight. But there's good prudence, and then there's groundless pessi- mism. A third-quarter 2011 FICO consumer credit risk survey, performed for the Professional Risk Managers' International Association, found stagger- ing gloom among risk manag- ers: "More respondents expect delinquency rates to increase rather than decrease on mort- gages, home equity lines, credit cards, student loans, and even auto loans, which had been a bright spot in previous surveys," the authors wrote. A whopping 73 percent of the risk managers polled said they expected mort- gage defaults to stay elevated for at least another five years. risk with overlays, heaping new credit requirements on top of government standards. That's a dangerous practice: For the past year, HUD has been investigat- ing 22 lenders for denying FHA loans to minority borrowers with FICO scores as high as 640. (The FHA standard is to lend to a qualified borrower over 580 with as little as 3.5 percent down.) From the government's standpoint, overlays are ripe for abuse of fair lending standards; a bank that tries to lower its risks in this way ironically risks big trouble with regulators. Consumers probably don't realize that increased underwrit- ing standards aren't just a hassle for them. "If I'm a lender, my costs of compliance have gone way up," Cutts says. From fraud prevention and early-warning tools to streamlining the origina- tion process and beyond, there's a million new headaches for banks. In early February, Fitch Ratings predicted a sharp rise in the cost of mortgage origination and servicing, "We think the cost of servicing a performing mortgage could increase by as much as 25 percent to 50 percent from pre-crisis levels and for nonperforming loans, servic- ing costs are likely to double, or more." That's good news for special servicers, but not for big banks looking at stagnant volumes of prime and subprime mortgages. Crews Cutts says these new costs are one place where lenders can simplify and save some cash, though: They can court new third-party service providers. She plugs Equifax's Undisclosed Debt Monitoring service, a platform that keeps tabs on borrowers in the lull between the first credit check and the loan closing. "It relieves lenders of a major head- ache," she says. Hope for a Change . . . in Washington and Wall Street S o banks and consumers are both skittish, hesitant to put much trust in each other. And while both sides may have to power through and give some ground, there's another party that can help stimulate borrower interest and looser underwriting: the federal government. Through this crisis, the up-and-down regulatory ride has taken its toll on credit standards. "Whenever there is regulatory uncertainty, you go to the most conservative decision," Crews Cutts says. But with the Consumer Financial Protection Bureau getting off the ground, and a servicer settlement being inked by the country's state attorneys general, and with Dodd-Frank in the rearview—for now—bankers and borrowers alike may finally get some much- needed predictability out of