This is the first segment in a series that provides true or false questions to amplify residential mortgage issues. The initial article includes questions about the mortgage securitization process.
True or False? — T/F: Securitization of Residential Mortgages
Here are eight questions that focus on residential loan securitizing (explanations and answers are shown in the next section):
- 1 — Securitized residential mortgages are created when multiple real estate loans are combined into a marketable security. — T or F
- 2 — Financial securitization originated in the 2002-2007 time period. — T or F
- 3 — About 33 percent of residential real estate financing is now securitized. — T or F
- 4 — Since 1970, real estate loans have been the only form of securitized debt. — T or F
- 5 — Freddie Mac (the Federal Home Loan Mortgage Corporation) issued and guaranteed the first version of mortgage pass-through securities. — T or F
- 6 — In the United States, all securitized mortgages since 2004 have been issued by federal agencies. — T or F
- 7 — During June 2019, Freddie Mac and Fannie Mae began the issuance of a standardized security known as the Uniform Mortgage-Backed Security (UMBS). — T or F
- 8 — Due to the newness of this specialized asset, securitized non-qualified mortgage (non-QM) loan pools exhibited only a small trading volume during 2015 and 2016. — T or F
Answers and Explanations: Securitizing Mortgages
1 — True. Each mortgage lender has a specialized rationale and process for securitizing residential real estate loans.
2 — False. The practice of securitizing financial instruments began during the 17th century while securitization of real estate debt started in the 19th century (farm railroad mortgage bonds). Contemporary securitized vehicles in the United States originated when the Department of Housing and Urban Development (HUD) established residential mortgage-backed securities (1970).
3 — False. Securitized mortgages currently represent approximately 70 percent of financing activity. This amounts to approximately $7.5 trillion of outstanding residential mortgages.
4 — False. Securitizing is the process of pooling any debt vehicles. Auto loans and credit card obligations are two prominent current examples of non-mortgage instruments that are regularly securitized.
5 — False. Ginnie Mae (the Government National Mortgage Association, created by the Housing and Urban Development Act of 1968) issued/guaranteed the initial version of mortgage-backed securities. Additional securitization activities were executed by Fannie Mae (the Federal National Mortgage Association) and Freddie Mac. For example, Fannie Mae issued the first CMOs (collateralized mortgage obligations) in 1983.
6 — False. For several decades after Ginnie Mae issued securitized mortgages, residential mortgage-backed securities (RMBS) consisted entirely of real estate loans backed by government agencies. The establishment of non-qualified mortgages (non-QM) provided a new and practical form of mortgage loans to borrowers who cannot obtain qualified mortgages (QM). However, non-QM loans and other non-Agency mortgages cannot be packaged as government agency (such as Freddie Mac, Ginnie Mae or Fannie Mae) securities. Without the securitization process, market liquidity is extremely limited. To successfully overcome this challenge, non-QM assets are now being securitized by mortgage-related companies such as New Residential Investment Corp. For example, New Residential issued mortgage securitizations totaling $3.8 billion during 2018. These non-Agency assets have proven to be an accepted component in an active market.
7 — True. The standardization process was designed to improve the housing finance system in the United States. While the stated intent of this initiative was to lower mortgage rates, many observers believe that the primary goal was to unify in excess of $4 trillion of mortgage-backed securities issued by multiple federal agencies.
8 — True. As investors became more acquainted with the competitive advantages of non-QM choices and borrowers gradually embraced the more flexible mortgages, the increasing popularity led to a rising volume of non-QM securitization. As documented by Standard & Poor’s in late 2018, non-QM securities represent the fastest-growing segment of non-Agency RMBS.
True or False, Part 2: Mortgage Defaults
This is the second article in a three-part series using a collection of true or false statements about the residential mortgage industry. Part one discussed securitizing, and this segment will examine the residential mortgage default process.
True or False? — T/F: The Mortgage Default Process
Here are seven examples that examine knowledge about defaults in mortgage-related transactions (answers and explanations are provided after all of the true or false questions are listed):
- 1 — Residential mortgages originated between 2004 and 2008 produced less than 20 percent of current foreclosures. — T or F
- 2 — Foreclosures are higher in “non-judicial” states. — T or F
- 3 — The foreclosure process is more expensive than loan workout strategies. — T or F
- 4 — In the United States, foreclosure filings exceeded 600,000 during 2018. — T or F
- 5 — Mortgage delinquencies and defaults include payments that are at least five days late. — T or F
- 6 — The foreclosure inventory (all mortgages in foreclosure) was recently at the lowest percentage in 24 years. — T or F
- 7 — During the 2007 financial crisis and the aftermath, non-bank mortgage servicing companies emphasized efforts to arrange mortgage workouts and improve collections whenever possible while bank-owned mortgage servicing companies predominantly sought asset sales via short sales and foreclosures. — T or F
Answers and Explanations: Residential Mortgage Defaults
1 — False. The period immediately preceding the 2007 financial crisis generated a majority of recent foreclosures. While mortgage loans initiated during 2004-2008 amount to about 15 percent of total mortgages in the U.S., this origination period resulted in almost 60 percent of current foreclosed loans.
2 — False. States that require lenders to use judicial procedures for foreclosures are referred to as judicial states and have a higher foreclosure rate (about 1 percent in 2018) than non-judicial states. The foreclosure process in judicial states involves lenders producing evidence of delinquencies to courts instead of simply issuing a notice of default (without court involvement) in non-judicial locations — this necessitates an extended timeline due to additional requirements. Recent data reveals that judicial states have just under 70 percent of mortgages in foreclosure proceedings (resulting from 40 percent of all residential mortgages in the country). During the peak foreclosure period, the foreclosure rate was about 2.5 percent for non-judicial states and 5 percent in judicial states. Foreclosure activity in judicial states has not yet returned to pre-crisis levels.
3 — True. For investors, mortgage loan workouts have the potential to replace non-performing loans with re-performing portfolios after payments resume. As Henry Paulson (former Secretary of the Treasury) reported during the financial crisis, “Foreclosure is to no one’s benefit. I’ve heard estimates that mortgage investors lose 40 to 50 percent on their investment if it goes into foreclosure.” According to the Joint Economic Committee of Congress, an average foreclosure costs lenders about $50,000 while foreclosure avoidance costs are about $3300.
4 — True. However, the total was 2.9 million during the peak period for foreclosures in 2010.
5 — False. Delinquencies represent failure to make a payment for an extended period: usually categorized by 30, 60, 90, 120 days or more. A legal mortgage default is typically triggered by missing payments for 90 days or more. Based on mortgage data for 2018, a delinquency of at least 30 days occurred with about 3 percent of residential mortgages.
6 — True. The percentage of all mortgages in foreclosure was recently at 0.92 percent. However, this rate was 3.6 percent during 2010-11 and even higher in specific states such as Florida (12.5 percent). The rate in Florida was recently 1.5 percent.
7 — True. Loan workouts historically produce better outcomes for all mortgage stakeholders. For example, New Residential Investment Corp. has prioritized loan modifications and better collections since the company was founded in 2013. A New Residential subsidiary acquired in 2018, Shellpoint Mortgage Servicing, is a major non-bank servicer that integrates the workout strategy in daily operations.
True or False, Part 3: The Fed and Federal Agencies
This is the final part in a series featuring a true-or-false format about residential mortgages. The first two segments described mortgage defaults and securitizing. This article will take a closer look at the role of federal agencies and the Federal Reserve (The Fed).
True or False? — T/F: Federal Agencies and the Fed
Here are eight questions that cover federal government control of the residential mortgage process (answers are shown after all of the true/false questions):
- 1 — The Federal Reserve maintains a confidential list of troubled banks known as the Problem Bank List. — T or F
- 2 — The Federal Home Loan Mortgage Corporation (usually referred to as Freddie Mac) and the Government National Mortgage Association (known as Ginnie Mae) were created during the Great Depression. — T or F
- 3 — The Fed sets both commercial and residential mortgage interest rates. — T or F
- 4 — Agency versions of residential mortgage-backed securities (RMBS) involve federal housing agency mortgages. — T or F
- 5 — The highest fed funds rate during the past 50 years was 20 percent. — T or F
- 6 — The lowest fed funds rate during the past 50 years was 1 — T or F
- 7 — The Federal National Mortgage Association (Fannie Mae) and Freddie Mac were placed into a conservatorship in 2008. — T or F
- 8 — The Federal Reserve Banks are a part of the federal government. — T or F
Answers and Explanations: The Federal Reserve and Federal Agencies
1 — False. The Problem Bank List is maintained by the Federal Deposit Insurance Corporation (FDIC).
2 — False. Freddie Mac was established in 1970 and Ginnie Mae was created in 1968.
3 — False. However, the Fed does set the federal funds rate that usually impacts short-term interest rates and some adjustable (variable) rates. As of October 2, 2019, the fed funds rate was 2 percent.
4 — True. Federal agency mortgage assets are usually referred to as qualified mortgages (QM).
5 — True. To control double-digit inflation, the Federal Reserve raised the fed funds rate as high as 20 percent during 1979-1980. The challenges of excessive inflation began when President Nixon removed the gold standard from the U.S. dollar in 1973. Inflation initially increased to 9.6 percent (from 3.9 percent) and the Fed increased the fed funds rate to 11 percent (from 5.75 percent). Although the fed funds rate was both raised and lowered between 1974 and 1980, Paul Volcker (Federal Reserve chair) decided to keep rates at a high level until inflation ended. This resulted in the 1980 recession but did effectively end double-digit inflation.
6 — False. When the fed funds rate was lowered to 1 percent in 2003, it was the lowest rate seen until December 17, 2008 when the Fed lowered the rate to 0.25 percent. After that reduction, rates were not raised until December 2015.
7 — True. The federal government eventually provided hundreds of billions of dollars that enabled these government-sponsored enterprises (GSEs) to survive the multiple challenges of the housing crisis. During the conservatorship, profits generated by the two GSEs were directed to the U.S. Treasury to repay the earlier bailouts. Recent plans were announced to end the conservatorship status, but Congressional action appears to be necessary before this change is finalized.
8 — False. While the Federal Reserve System was created due to an act of Congress (the Federal Reserve Act) in 1913, the Federal Reserve Banks are not a part of the government. The banks are set up like corporations — member banks earn dividends and hold stock. There are 12 Federal Reserve District Banks, and member banks appoint two-thirds of each Bank’s board of directors. All members of the Federal Reserve Board of Governors must be approved by the President and Congress. Terms of board members are staggered so that appointments will not coincide with traditional elections, and board decisions are not subject to the approval of any elected officials.
FYI — Mortgage Investments: NRZ and Michael Nierenberg
New Residential Investment Corp. (NYSE: NRZ) has paid out almost $3 billion in total dividends to shareholders since the company was founded in 2013. Based on the October 2, 2019 closing price of NRZ common shares ($14.76), the 2018 dividend of $2 per share (paid quarterly) represents a yield of 13.5 percent. Michael Nierenberg leads the executive management team for New Residential. He has facilitated long-overdue improvements in the mortgage industry and was instrumental in forming NRZ at an opportune time.