Mortgage Lending in 2014 What Are the Drivers Brinkmann

Mortgage Lending in 2014 and Beyond:

What Are the Drivers?

Jay Brinkmann*

Chief Economist and

SVP, Research & Education

Mortgage Bankers Association

*Comments and opinions are solely those of the

presenter and do not necessarily represent official

positions of the MBA or its members.

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Five Major Drivers Impacting the Market

1) Higher severity costs will continue to lower

acceptable default rates and thus tighten credit

criteria.

2) Lending will be concentrated inside the CFPB

safe harbor definition or go to FHA.

3) The cost of originating a mortgage will continue

to go up. Which business models survive?

4) Banks will increasing weigh the legal and

reputational risks of mortgage banking against

reduced volumes and profitability.

5) The securitization and servicing models are

being challenged by QRM and Basel III.

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1) Causes of Higher Severity Costs

1) Regulatory requirements for how to deal with defaulted

borrowers driving up servicing costs.

2) Lengthened legal timelines, particularly in judicial

foreclosure states.

3) Zero-tolerance in buyback demands from GSEs and

False Claims Act actions by FHA.

4) Liability under ability to repay provisions of QM for non-

safe harbor loans. Legal costs plus potential legal

damages.

4

6.22

2.13

4.09

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00(Percent, NSA)

Judicial States

Non-Judicial States

Difference

Loans in the Process of Foreclosure by Judicial

and Non-Judicial States

Source: MBA National Delinquency Survey

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2) CFPB’s Qualified Mortgage Rule

• The ability to repay rule puts considerable potential liability

on lenders who lend outside of the safe harbor guidelines.

• A successful lawsuit against a lender would likely cost in

the range of $180,000 to $200,000.

• The legal defense expenses on unsuccessful suits would

likely run in the range of $40,000.

• Per loan profits are in the range of $2,000, and will likely

be lower in a lower volume environment.

• Is the risk of a non-safe harbor loan worth it?

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3) Loan Production Costs Going Up

7

Retail Apps per Underwriter per Month

188

152

134

165

126

103

124

113

75

60

193

120

102

124

99

112

82

94

72

57

0

50

100

150

200

250

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Large Lenders Small Lenders

Source: MBA/STRATMOR Peer Group Survey

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4) Reputation Risk

What are the reputational risks for being in the mortgage

business? What is the potential damage the value of the rest

of the franchise?

• Servicing complaints

• Fair lending

• DOJ and HUD actions on disparate impact claims

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2011 Data Show Net Exit from Business

6,500

7,000

7,500

8,000

8,500

9,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Number of Institutions Reporting HMDA Data

Source: FFIEC

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5) Basel III Risk Weights for Residential Mortgages

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Basel III Impact on Mortgages Held in Portfolio

Funding examples for 95 LTV mortgage with MI:

Category 1 Mortgage Category 2 Mortgage

Mortgage 100$ Mortgage 100$

Funded with Cost Funded with Cost

Deposits 96$ 2% Deposits 96$ 2%

Equity 4$ 15% Equity 4$ 15%

Total cost 2.52% Total cost 2.52%

Under Basel III: Under Basel III:

Funded with Cost Funded with Cost

Deposits 92$ 2% Deposits 84$ 2%

Equity 8$ 15% Equity 16$ 15%

Total cost 3.04% Total cost 4.08%

Increase: 0.52% Increase: 1.56%

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Impact of Basel III on Mortgage Servicing Rights

Basel III will make it very expensive for banks to hold

mortgage servicing rights:

• MSRs more than 10% of Tier 1 capital must be deducted

from equity. Given fluctuations in MSR values due to

interest rates, the size of this deduction is unknown from

quarter to quarter.

• Remaining MSRs carry a 250% risk weight.

• MSRs plus most deferred tax items are limited to 15% of

Tier 1 capital.

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Impact of Basel III on Banks with MSRs

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Conclusions

• Higher severity costs are tightening credit and increasing

operational costs and compliance complexity favor big banks

and other large-scale operations, BUT

• Reputation and legal risk may cause them to pull back. Smaller

independents have been better at originating purchase

mortgages, BUT

• The regulatory complexities and potential QM liabilities and

increased GSE & FHA fees point toward putting more loans into

bank portfolios, BUT

• The increased Basel III capital requirements (and interest rate

risk of long-term, fixed rate mortgages) make that expensive,

particularly for riskier mortgages BUT

• Basel III requirements on MSRs and potential QRM retained risk

requirements make securitization a problem, BUT

• ?