January 31, 2022 | In this issue of The Institutional Risk Analyst, Chris Abate, CEO of Redwood Trust (RWT), discusses the world of non-agency mortgages after two years of COVID pandemic and related responses from the Federal Open Market Committee, Federal Housing Finance Agency and other state and federal organizations. Prior to 2008, half of all mortgages written in the US were private. Now almost 15 years on, some lenders are addicted to government subsidies for borrowers who don't need them, Abate writes, but regulators are rediscovering a trusted partner in the private mortgage sector.
In January of this year, the FHFA revised the GSE Enterprise Pricing Framework by increasing upfront fees (also known as loan-level pricing adjustments, or LLPAs) for certain high balance loans and loans on second homes. These changes are in keeping with the GSEs’ core mission of supporting sustainable homeownership and affordable rental housing. The changes will concentrate support to borrowers most in need of the valuable, and subsidized, liquidity that the GSE loan programs provide. As a partner to the GSEs and a leading voice for quality and innovation in the housing finance sector, Redwood Trust applauds this move by the FHFA.
Not surprisingly, however, not everyone is supportive. There remain a number of lenders and their K Street lobbyists who prefer cheap credit regardless of the cost to taxpayers. They promote nonfactual scare tactics or alarmist arguments in hopes of maintaining status-quo subsidies – and easy profits – for loans to higher income borrowers.
The recent LLPA increases put forth by FHFA Acting Director Sandra Thompson were a bold move. They are the clearest acknowledgment yet that government subsidization of certain parts of the mortgage market is unnecessary when the private market continues to serve them efficiently. By focusing GSE capital and resources where they are needed most, the FHFA is achieving a few very important objectives: greater support for the GSEs’ mission-driven activities, increased safety and soundness, and the continued “crowding in” of private capital in areas where specialized underwriting and loan administration expertise can more effectively serve homebuyers.
We all know the dynamics in today’s housing market are unprecedented. Record high home prices and an elevated demand for homes, with extremely low levels of inventory, characterize markets in many parts of the country. Without a rationalization of mortgage subsidies, the GSEs could assume unnecessary risk on mortgages to homebuyers with incomes well in excess of the median in their own neighborhoods. In fact, household income of two times the area median is often required to support debt payments on higher balance loans, assuming a reasonable debt-to-income ratio of 40%. These can hardly be described as “mission serving” borrowers, and the considerations in extending them credit are anything but homogenous.
The upward trend of GSE purchases toward larger loans is already well established. High balance loans represented approximately 11% of GSE purchases in 2021, up from 8.2% in 2018. In addition, since 2018, the average size of a high balance loan purchased by the GSEs has increased 21%.
(1) Source: 1010 Data, Falcon Capital Advisors
Importantly, the GSE regulator also seems to recognize this trend and is taking action. Along with the LLPA increases on high balance loans, the FHFA recently rejected as insufficient the GSEs’ “Duty to Serve” plans, which among other things, outline efforts to provide liquidity for affordable housing in underserved markets.
Today’s Private Mortgage Sector
The role of the private mortgage sector, in a competitive sense, has always been to serve markets that federally subsidized loan programs don’t reach. And the fact is, Redwood and others have already demonstrated the ability to seamlessly fill gaps whenever the GSE footprint has been reduced, and to do so with no discernible impact on borrower’s interest rates or process efficiency.
Just last year, the private sector collectively executed a 400% increase in securitization volume of Agency-eligible loans – responding immediately and effectively to regulatory shifts impacting the GSE financing of mortgages on non-owner occupied homes. And as the private sector expanded, it continued to offer rates to homebuyers that were near or better than those offered through the GSEs, underscoring the maturity of the private market.
The chart below illustrates the relationship between conforming (GSE) and private sector consumer mortgage rates over the past several years, along with annual volumes.
Borrowers continue to benefit from the strong presence of the private mortgage sector. It is now estimated that a typical borrower could see a marginal rate benefit of between 0.125% to 0.25% for high balance loans and 0.25% to 1% for second homes. Along with added purchasing power, consumers benefit from private sector sponsors with deep experience in the risk-based underwriting and pricing of their home loans.
At Redwood, we help make quality housing accessible to all American households. We work in support of the safety and soundness principles emphasized by the FHFA to help ensure a strong and stable housing finance market. Since 2010, Redwood alone has purchased over $50 billion of loans from our origination partners and distributed them through a combination of private-label securitizations that we sponsor, and whole loan portfolio sales to leading depositories, insurance companies, and other quality institutional investors.
Our emphasis on speed to closing and reliable execution has helped to institutionalize private sector workflows in tandem with traditional GSE workstreams. We’re also leading the charge to innovate in an industry that has long been characterized by archaic systems and processes. Some recent examples include our Rapid Funding program and our use of Blockchain technology in securitization, reflecting our commitment to ensuring a powerful liquidity alternative for home owners as regulators determine the future priorities of the GSEs.
We see a bright future ahead for the private label loan market and, again, applaud the FHFA for having the courage to let the markets work best for those borrowers who clearly need no assistance from the taxpayer.