Jun. 4, 2013: Regulators branching out; FHA addresses QM, CFPB, and Reg. Z; FHA & DOJ ramping up enforcement actions
Rob Chrisman

Periodically I am asked about statistics of new houses. Fortunately the Census Bureau is once again here to help. It has produced the “2012 Characteristics of New Housing” which provides annual statistics on the characteristics of new privately owned residential structures such as the type of wall material, number of bedrooms and bathrooms, type of financing, heating and square footage, for the U.S. and the four national regions. Dig in: http://www.census.gov/construction/chars/.


“Rob, how can I gear up my consumer direct division to go after purchase business?” That is a good question to which I don’t know the answer – wish I did. Consumer direct purchase business certainly seems to be the Holy Grail that many companies would like to find, and you can bet that the big players in this origination channel are focused on it. Good luck!


Regulators are definitely branching out and have announced that they will be regulating nonbank, systemically important companies. As a side note, in many cases its employees are earning significant amounts of income more than the employees of the companies they regulate but interestingly I am continuing to hear continued reports of large turnover at institutions like the CFPB. But here is the latest on the regulators spreading their wings: http://www.usatoday.com/story/money/business/2013/06/03/regulators-firms-oversight/2385855/.


As California goes, so goes the nation? In this case, let’s hope not. Saturday the commentary had the latest on eminent domain out of California. And now out of that state we have another legal tactic stalling foreclosures. California's notorious Homeowner's Bill of Rights passed last year and news has arisen that a Sacramento-area borrower has won a preliminary injunction against one of the nation's largest banks halting the foreclosure.  According to news reports and court documents, the borrower claimed his servicer had “dual-tracked” his loan, offering loan modification assistance while simultaneously proceeding with foreclosure processing - banned under the 49-state National Mortgage Settlement, and codified into California law last year.  What should be most ominous for servicers, however, is not necessarily the content of the complaint or the suit's outcome.  Typically the law and the courts require plaintiffs to successfully plead their case in order to win attorney's fees (a disincentive to file frivolous lawsuits) but in the Sacramento case, attorney's fees may be awarded simply for securing the preliminary injunction, a much lower hurdle than in the past, and a dangerous precedent going forward.  Here is the scoop: http://www.sacbee.com/2013/05/23/5441875/west-sacramento-homeowner-uses.html.


Just when I was wondering last night what I was going to write about this morning, along come a memo from Carol Galante addressing the recent changes in FHA loans and their relation to Reg. Z, QM, higher priced mortgage loans, and the CFPB! Thank you Carol – it is important, and I have the announcement in its entirety. “With the implementation of Mortgagee Letter 2013-04 on June 3, 2013, the monthly mortgage insurance premium on FHA loans with loan-to-value ratios exceeding 90% will apply for the life of the loan, rather than terminating when the loan amortizes to a 78% LTV.  FHA recognizes that this change in policy will increase the annual percentage rate (APR) on FHA mortgages and may result in mortgages that exceed the higher priced mortgage loan standard outlined in Regulation Z.


“Regulation Z defines a higher-priced mortgage loan (HPML) as a consumer credit transaction secured by the consumer's principal dwelling with an APR that exceeds the average prime offer rate (APOR) for a comparable transaction as of the date the interest rate is set, by 1.5 or more percentage points for loans secured by a first lien, or by 3.5 or more percentage points for loans secured by a subordinate lien.  (The escrow account requirements also employ a separate threshold of 2.5 percentage points over APOR for “jumbo” mortgages, but this is not relevant for FHA loans.)


“To the extent lenders are concerned about the status of FHA’s rulemaking with respect to the Dodd-Frank ability to repay standard and FHA’s qualified mortgage standards, FHA is working to define an FHA QM standard that meets the Dodd-Frank purposes, takes HPMLs into account,  and addresses the needs of the marketplace for lender and investor certainty.  FHA looks forward to the active engagement of all interested parties in achieving a timely and thoughtful approach to these complex issues.


“In the near term, FHA understands that mortgages exceeding the HPML threshold will also have to comply with the existing requirements for such loans under Regulation Z.  This is currently true for FHA loans that exceed the HPML threshold, but we understand that implementation of ML 2013-04 may cause additional loans to exceed this threshold.  We have heard that some lenders have concerns about these existing requirements and, in an effort to address those concerns, have consulted with the Consumer Financial Protection Bureau (CFPB) on the following guidance related to escrow accounts, appraisals, ability to repay and prepayment penalties.


“FHA expects lenders to fully comply with all applicable requirements for loan origination, including requirements that are established under Regulation Z for HPMLs. We have outlined below where HPML requirements would differ from FHA requirements: 1. Escrow Accounts:  Regulation Z requires an escrow account for all first-lien HPMLs. Escrow accounts are also required on all FHA loans.  Although the HPML rules generally permit (but do not require) cancellation of mandatory escrow accounts after five years and upon the consumer’s request, FHA does not permit cancellation of required escrow accounts at any time, thus lenders may not cancel escrow accounts on FHA loans whether they are HPMLs or not.


2. Appraisals:  The existing Regulation Z does not contain specific appraisal requirements and lenders are expected to continue complying with FHA’s appraisal requirements.  Commencing January 18, 2014, Regulation Z’s appraisal requirements will require a full, interior-inspection appraisal for HPMLs with some exceptions.  One such exception is for QMs. 3. Ability to Repay:  The CFPB has outlined its ability-to-repay requirements in its final rule that will take effect January 10, 2014.  In the interim period before those requirements become effective, the repayment ability requirement previously established by the Federal Reserve Board at 12 CFR 1026.35(b)(1), which will move to section 1026.35(e)(1) as of June 1, 2013, continues to apply.  FHA has consulted with the CFPB and believes that its requirements, found in the current 4155.1, are sufficient to satisfy the Regulation Z ability-to-repay requirements for those FHA-insured loans that will be HPMLs, with certain exceptions:  Streamline Refinances and ARMs may not satisfy the existing, HPML ability-to-repay requirements, depending on how they are underwritten. For example, Streamline Refinances that are HPMLs, and where income or assets relied on are not verified by obtaining confirming documentation, do not meet the ability-to-repay requirements.  For these exceptions, lenders must go beyond the applicable FHA requirements to comply with the HPML ability-to-repay requirements.


“4. Prepayment Penalties:  CFPB has determined that monthly interest accrual amortization, which FHA permits, should be considered a prepayment penalty.  However, recognizing that HUD must engage in rulemaking to end this practice, CFPB has stated in its final rule published on January 30, 2013, that monthly interest accrual amortization is not a prepayment penalty for FHA loans consummated before January 21, 2015.”


And Brian Montgomery, the Chairman of The Collingwood Group, sent a note to clients alerting them of how the FHA & DOJ are pursuing a ramp-up of enforcement actions. “It appears that the Federal Housing Administration (FHA) and other federal agencies have pursued a ramp up of enforcement actions against mortgage lenders in recent weeks. According to individual private accounts, over a dozen mortgage lenders have received notification letters for enforcement actions as well as Direct Endorsement (DE) terminations in May. At least two lenders have also recently reported receiving allegations from the Department of Justice that they are in violation of the False Claims Act. Accounts of these actions have quickly raised industry concern about what is underway at HUD (including the HUD Office of the Inspector General) and how to best manage FHA claims and enforcement actions in an already challenging market and regulatory environment.


“The catalyst for the increase in enforcement actions remains to be seen, however, the industry has experienced similar enforcement initiatives in the past…FHA False Claims Act violation allegations have also increased in recent years as a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) increasing damages available under the statute. Under False Claims Act allegations, FHA has charged lenders with falsely representing loans insured by FHA.  However, given the subjectivity of certain DE requirements and the time elapsed between origination of the loan and the time the suit is brought, it can be difficult for lenders to manage their exposure.  False Claims settlements have been enormously costly for lenders.


“…the increase in enforcement actions poses serious threats to lender operations. If a lender has their DE authority terminated, they must wait at least six months before applying to reinstate their DE status, in effect halting all FHA business, including both retail and third party originator business in the geographic region. These lenders must also hire a certified public accountant (CPA) to conduct an audit to appeal FHA actions and may need to engage in-house or outside counsel for legal support. In addition to the business costs of these actions, including time, profit and resources lost or expended, lenders also incur reputational risk.  All FHA DE terminations are published in the Federal Register for customers, competitors and the media to see. False Claims Act settlements between the Department of Justice and mortgage lenders have also been widely publicized.


Lenders who have already received enforcement action notifications should act deliberately and quickly to respond to these serious claims.  Lenders should also be thorough in their internal file reviews and familiar with FHA processes. Lenders that have not received enforcement actions should act cautiously and defensively, devoting considerable resources to quality control, training and performance monitoring. In addition to internal compliance preparation and response, lenders should work with experienced third party providers to support their responses and planning for FHA enforcement actions.” Thank you Mr. Montgomery from The Collingwood Group.


This daily blather is focused on mortgage lending rather than investment chatter, but this caught my eye. The dividend yield for the S&P 500 currently stands at 1.96%. For the first time in several years, the yield on 10-yr treasuries is higher, rising from 1.66% at the beginning of May to its current level of 2.13%. So what? Well, Mitch Zacks writes, “As a result, the great dividend trade, which is being driven by the difference between the yield on fixed income securities and the dividend yield from owning equities, is likely to come under some pressure in the immediate future. At the end of the day, the attractiveness of owning dividend yielding securities diminishes as the interest rates on treasuries rise. Does that mean you should start rotating out of dividend paying stocks and into non-dividend paying stocks? I would say no. Over long periods of time, a basket of dividend paying stocks has tended to outperform a basket of non-dividend paying stocks. If you examine the performance of these two stock baskets over decades, then you will see that the Alpha, or outperformance, of the dividend paying stocks materializes more in down markets as opposed to up markets. Essentially, dividend paying stocks have historically outperformed non-dividend paying stocks by performing better in down markets while lagging non-dividend paying stocks in up markets.”


So although there is not a 1:1 correlation, folks use the yield on the 10-yr to gauge MBS movement. The yield on the 10-year Treasury note closed at an all-time low of 1.39% on 7/24/12.  Since then, the yield on the 10-year note has climbed to 2.13%. Not only has the S&P rallied nicely (over the same 10-month period, the S&P 500 has gained +24.3% on a total return basis) but an investor would have had that dividend income. For companies, interest to bondholders is tax deductible, while divided payments to shareholders are not.


It was a decent day in the fixed-income markets Monday, which was (for lack of anything else better) attributed to the Institute of Supply Management’s factory index. Manufacturing in the U.S. unexpectedly contracted in May at the fastest pace in four years, with the factory index falling to “49” from the prior month’s “50.7.” Fifty is the dividing line between growth and contraction, and last month’s reading was the lowest since June 2009. Aside from a secondary number like that moving the markets, one would expect some bounce, or at least a breather, given what rates have done recently. Traders reported a light volume day for residential MBS, and the lack of supply, coupled by the usual demand, helped prices, and we saw plenty of improvements.


By the end of Monday the 10-yr sat at a yield of 2.13%. Here this morning we don’t have much scheduled news (8:30AM EDT April International Trade Balance, which came in a little better than expected), and in the early going the market is pretty quiet with the 10-yr sitting at 2.14% and MBS prices roughly unchanged.



An older gentleman was on the operating table awaiting surgery and he insisted that his son, a renowned surgeon, perform the operation.

As he was about to receive the anesthesia, he asked to speak to his son.

“Yes, Dad, what is it?”

“Don’t be nervous, son. Do your best and just remember, if it doesn’t go well, if something happens to me, your mother is going to come and live with you and your wife. Forever.”



If you're interested, visit my twice-a-month blog at the STRATMOR Group web site located at www.stratmorgroup.com. The current blog is, “Mortgage Backed Securities: Life after QE3." If you have both the time and inclination, make a comment on what I have written, or on other comments so that folks can learn what's going on out there from the other readers.


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