GSE "Black Boxes" and Reps/Warrants Must Change – MBA

<pThe Mortgage BankersrnAssociation released the fourth of five planned concept papersrnwhich recommend immediate steps the FederalrnHousing Finance Agency (FHFA) and Fannie Mae and Freddie Mac (thernGSEs) can take to ease the transition to a new secondary mortgagernmarket. Keys to ExpandingrnCredit Access: A Common Credit Box And Clearer Representations andrnWarranties outlines steps to ensurernlenders have the confidence to lend to the full range of qualifiedrnborrowers.  Aligning the GSEs’ underwriting standards andrncreating clear standards for representations and warranties, isrnessential for a smooth transition to a sustainable secondary marketrnoperating with an explicit, limited government guarantee.</p

MBArnsays that the two separate automated underwriting systems (AUS)rndeveloped by Fannie Mae and Freddie Mac continue to be “blackrnboxes,” masking their underwriting standards from theirrncustomers. Fannie Mae’s Desktop Underwriter (DU) and Freddie Mac”srnLoan Prospector (LP) are the primary tools used to establish creditrnstandards for the companies and determine whether loans are eligiblernfor their purchase or financing. </p<pCompetition betweenrnthe two GSEs often took the form of "underwriting variances"rnwith their larger customers. Fannie Mae positioned itself as morernlenient on credit scores, documentation, and promoted product typesrnsuch as Alt-A and high loan-to-value loans with minimum mortgagerninsurance. Freddie Mac negotiated other types of variances. </p<pThisrnmade standards even more opaque, and these variances masked the realrnrisks the GSEs were taking from regulators and Congress. Despiternbeing in government conservatorship the two are still not transparentrnabout their AUS credit standards. Thisrnsituationrnneedsrntornchangerninrnorderrntorncreaternarnpathrntornarnnewrnandrnmorerncompetitivernsecondaryrnmortgagernmarket.rn</p<pEvenrnthough the GSE are no longer competing and have no capital base orrna way of increasing capital over time, they and their regulatorrncontinue to pursue policies that unintentionally undermine the healthrnof the mortgage market. This includes pursuing repurchases andrnindemnifications from lenders on old mortgages where there is only arntenuous connection between underwriting and default. Thus a commonrnstandard for representations and warranties is also needed.</p<pThernGSEs are not betting with their own money, they are betting withrntaxpayer money and it does not make sense to have multiple creditrnmodels from GSEs competing in the same market. There is no reason tornhave two different government-backed black box underwriting systems. </p<pThernFederal Housing Finance Agency should set the parameters forrnacceptable underwriting criteria for both GSES and then allow them tornoffer credit terms within their outer boundary. The Ability to Repayrnand Qualified Mortgage rules promulgated by the Consumer FinancialrnProtection Agency is a step in this direction but FHFA shouldrnconsider extending these rules since the GSEs are interpreting thernstandards to mean that investor property loans will not have anyrnrestrictions on credit. </p

Nextrnthe two GSEs should be required to synchronize their underwritingrnengines by year end which would eliminate unnecessary differences andrnlevel the playing field for all lenders who deliver loans to eitherrnGSE. Without an identical match across all variables, there would bernadverse selection as lenders seek to exploit whichever GSE has weakerrnstandards. </p

Alternatively,rnFHFA could turn off one of the underwriting systems and embed bothrnsets of parameters within a single system. By utilizing the samernunderwriting engine credit variances would become more transparentrnwhich would facilitate credit access.rn</p<pInrnfact, this type of approach could include credit scorecards fromrnother guarantors and may provide a good model for a future creditrnsystem which would clearly indicate the available choices for lendersrnand consumers and break the black box. The Qualified Mortgagerndefinition would still demarcate the outer boundaries of the creditrnbox. </p<pCreditrndifferences lead to differences in prepay speeds and aligningrnunderwriting standards will help to resolve this problem. Also somerninvestors have been reluctant to move to a common security because ofrncredit differences between the GSEs. A common security is criticalrnto increasing liquidity in the market and saving money for taxpayers.</p<pFinally,rnFHFA needs to implement additional clarifications and refinements tornthe reps and warrants framework. While FHFA has made some progressrnwith its recent alignment initiative, more work needs to be done torndevelop a framework that would:</p<ol<li<p Holdrnlenders responsible for what they control, that is origination andrnservicing practices.</p</li<li<p Clearlyrndefine material underwriting breaches.</p</li<li<p Requirerna causal link between the breach and a default.</p</li<li<p Establishrna performance benchmark after which reps and warrants arernextinguished.</p</li</ol<pWithrnclear standards for defining material defects and a commonrnunderstanding of when such defects have a causal link to default,rnlenders will be more comfortable with eliminating credit overlays andrnlending closer to the edges of the common credit box. </p<p"Confusionrnand uncertainty around representations and warranties standardsrncontinues to cause lenders to add their own overlays to the existingrnGSE credit standards," said Bill Cosgrove, CMB, MBA’s VicernChairman.  “As a result, lenders are only offering mortgagesrnto those with the most pristine credit for fear that any borrowerrndefault will trigger costly repurchase requests.  This is arnmajor contributor to the tight credit environment that is holdingrnback the housing recovery.”   </p

Inrnthe weeks ahead, MBA will release its final concept paper which willrnaddress FHFA’s Common Securitization Platform initiative.

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