|Friction With Fannie and FreddieSome subprime lenders unhappy with GSE participation
April 2, 2001
By Sam Garcia
The National Home Equity Mortgage Association (NHEMA) — whose members include home equity lenders and subprime lenders — held its annual conference recently in Palm Desert, California. One of the most heated sessions during the conference was “GSEs: A Role In The Subprime Market?” Included in the session were Gerald Friedman, Chairman of FM Watch — a coalition of associations that serve as a watchdog over the government sponsored enterprises; Arne Christenson, Senior Vice President – Regulatory Policy at Fannie Mae; Kirk Willison, Vice President, Industry and Trade Relations at Freddie Mac; and Charles Coudriet, Chairman of Saxon Mortgage Inc. and President of NHEMA.
The spirit of collaboration that has been present at many recent mortgage conferences was replaced with defensive dialogue from some of the subprime mortgage participants. Audience attendees were vocal in their support of some of the issues raised by the FM Watch Chairman.
Home Equity Loans
Mr. Friedman pointed out that home equity lending by the GSE’s was not the intention of congress. This is because proceeds from home equity mortgages are in fact not (usually) used to purchase a home, but instead to pay off consumer debt. In a subsequent phone interview, Mr. Friedman did say that refinance loans with no cash out — which also are not used to purchase a home — are ok because these transactions help improve consumers’ housing expense. Another speaker suggested that while the GSE’s have done a great job with first-time homeownership, their systems — which work well for ‘A’ lending — don’t work well for the home equity business. Home equity loans, as described above, don’t necessarily achieve what Mr. Willison said Freddie’s goal is: “To get more people housed.”
In a telephone interview with Fannie Mae spokesperson Janice Daue, she said that their charter clearly gives them the authority to make home equity loans because such loans improve the finances of American consumers. She said Fannie Mae’s mission is to serve borrowers who would otherwise not have access to mortgage funds. She did indicate, however, that home equity loans represent a very small percentage (<3%) of their overall lending activities.
A recent report from FM Watch suggested that the GSEs’ purchase of home equity loans — with the majority going for debt consolidation — is an example of how Fannie and Freddie “arbitrage their capital and borrowing advantages” as aggressive competition for market share.
The American Community Banker’s position is that Freddie Mac and Fannie Mae “should not be allowed to encroach on the subprime or home-equity mortgage markets in the ordinary course of operations, other than in targeted programs to low-income borrowers and borrowers in underserved communities.”
Charles Coudriet, the president of NHEMA, said that it is not a necessity for the GSE’s to be in the subprime mortgage market. Mr. Friedman said that while private banking corporations can only leverage at 15:1, the GSE’s can leverage at 30:1. In the phone interview, Mr. Friedman indicated that he is not opposed to subprime lending at Fannie and Freddie, but he did say that the lower pricing they bring to the industry due to their subsidies will bring yields down below market value, eliminating competition and hurting consumers in the long run.
Arne Christenson said that there is only a thirty to fifty basis point spread between the cost of funds for ‘AA’ rated companies and the GSE’s. However, another speaker indicated that the cost of funds is 100-200 basis points better for the GSE’s than for “us.”
Arne Christenson said it is hard to say whether Fannie Mae is in the subprime business because ‘subprime’ is hard to define. For example, Kirk Willison pointed out that one ‘A’ borrower may have a 600 FICO score while another with a 650 FICO score may be subprime. Mr. Christenson did indicate, however, that they are only prevented from doing jumbo loans per their underwriting standards. He said that areas where “we can have a positive impact, we will be involved in.” While not directly acknowledging that they purchase subprime mortgages, Ms. Daue said that due to expanded guidelines, during 2000 Fannie Mae purchased $1.5 billion in loans to borrowers previously considered subprime. At a House subcommittee hearing last week Fannie Mae’s Chief Financial Officer, Tim Howard, shed light on Fannie’s subprime intentions; when asked by the Congressional Panel about Fannie Mae’s purchase of loans that had previously been considered subprime, Mr. Howard said “Making loans to people with less than perfect credit is not only totally within our charter, it is something we should do and something that is right to do.”
During a separate session, Ken Harney, who is a syndicated columnist for the Washington Post, said Freddie Mac closed $10.9 billion in ‘A’ to ‘A-‘ loans and $7.7 billion in ‘C’ & ‘C-‘ loans last year. Mr. Harney also said that an anonymous individual from a lender told him that Freddie Mac routinely buys loans from them where the credit scores are as low as 550 (Mr. Harney said as low as 530 in a subsequent phone interview) and the debt ratios are more than 60%. He indicated that Freddie looked at its own subprime portfolio and found that it performs well. He said that the wide variance in subprime production between the two GSE’s may be partly attributable to the difference in their definitions of subprime loans.
At another session, Helen Eggers – who is the President of Equicredit, the subprime subsidiary of Bank of America – and a representative from a First Union subsidiary acknowledged their delicate positions with this subject because of sister organizations that have ongoing relationships with the GSE’s. At least two senior executives of a large subprime lender declined to talk on record about GSE subprime lending because of their sister organization’s ongoing relationship with Fannie Mae and Freddie Mac. This sentiment was echoed in a recent story about how the chief executives of Wells Fargo & Co., American International Group Inc. and J.P. Morgan Chase & Co. said that they have faced threats of retaliation in their business relationships with Fannie Mae and Freddie Mac for participating in FM Watch.
While the GSE’s may have an unfair advantage, their presence in subprime lending can only be positive for the industry if they can actually bring down the cost of funds for all participants and help provide liquidity during times of crisis. The cost of funds for GSE subprime lending would have to move with that of top subprime organizations, with no variance in the spread between the two as markets gyrate up and down.
In late 1998 Russia defaulted on payments of its bonds. At the same time, Asian countries experienced economic woes. As a result, investors fled high-risk instruments such as subprime mortgage backed securities, which in turn hurt some subprime lenders that depended on securitizations.
Although the decline in subprime securities was exacerbated by an adjustment to the assumptions about the estimated life of subprime mortgages, having Fannie and Freddie as major players in the subprime industry at that time may have lessened the impact to subprime players. Ms. Daue said that during that period Fannie helped maintain liquidity by committing to purchase $9.5 billion in (not necessarily subprime) mortgage backed securities. Mr. Christenson said the GSE’s fared well during the bond crisis and that they provide assurance of liquidity. A stronger association with Fannie Mae and Freddie Mac during this period could have provided assurance for subprime MBS investors.
The two GSE speakers expressed a desire to work with the subprime players through statements like Kirk Willison’s where he said that they do not know subprime as well as lenders in the audience but “want to learn so they can pass savings on.” Ms. Daue indicated that Fannie “wants to work with all lenders.”
At the same time that Rep Richard Baker is pursuing stricter oversight of Fannie and Freddie, Treasury Secretary Paul O’Neill — who was reported to have acknowledged that he is personal friends with Fannie Mae’s chief executive Franklin Raines — made supportive comments about the company’s operations. Ken Harney indicated that the current administration has no interest in reigning in Fannie or Freddie.
The government sponsored housing enterprises have publicly stated that they do not intend to originate loans directly from consumers. Mortgage brokers must deal with approved seller/servicers to utilize their conventional programs. Given an overall improvement to the entire subprime MBS market, the continued watchdog activities of government & nonprofit entities, and the continued commitment to stay out of direct and broker business, GSE participation in subprime mortgage lending could be a boon for the industry. Additional benefits may be found in utilizing existing GSE technology to help develop a uniform subprime automated underwriting model for an industry that has mostly steered clear of utilizing technology to enhance operations.
Furthermore, if they are to participate in establishing anti-predatory measures, subprime players could only benefit from an alliance with organizations that carry significant political clout. Additionally, a stronger alliance with the Mortgage Bankers Association of America could also enable subprime companies to see more participation in anti-predatory measures.
In reference to the rift between the GSE’s and some subprime lenders, Mr. Harney said “when the tiger walks into the temple, include him in the ceremony.”