Compensation: Coming or Going?

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions. He is the President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

Prophecy is above my pay grade, but if I were a betting man - which I'm not! - I would bet on a postponement of the TILA loan officer compensation requirements currently scheduled to go into effect on April 1, 2011. Rarely have I seen such a messy roll out of a regulatory change that actually affects virtually all aspects of the mortgage banking industry in general, and mortgage brokers in particular.

Because I'm not a betting man, I hope for the best outcome for industry stability, but will prepare for the "alternative." Our clients will be as prepared as possible, whatever the situation, come April 1, 2011!

Perfect Storm - Exhibit 1: Congress

The Senate's Committee on Banking, Housing, and Urban Affairs, chaired by Tim Johnson (R-SD), is concerned that "regulators are not allowing adequate time for meaningful public comment on their proposed rules. We also believe that regulators are not conducting rigorous analyses of the costs and benefits of their rules and the effects those rules could have on the economy."

Dated February 15, 2011, the letter was sent by ten members of the Committee to Timothy Geithner of the Treasury, Gary Gensler of the CFTC, Sheila Bair of the FDIC, Ben Bernanke of the FRS, Mary Schapiro of the SEC, and John Walsh of the OCC.

In their letter, the Senators observe what has become abundantly obvious to most industry members: "the unprecedented scope and pace of agency rulemakings under the Dodd-Frank Act make it more important than ever that agencies engage in deliberative and rational rulemaking."

The letter enumerates five questions for the recipients to answer, and here is my abbreviated version:

1. Will the respective agencies provide at least 60 days for public comment on all proposed rules and studies required by the Dodd-Frank Act?

2. What steps are being taken to ensure that the rules you adopt under the Dodd-Frank Act are the least burdensome way to achieve the statutory mandate. (Provide how those steps satisfy the obligations under the Administrative Procedure Act and other applicable statutes to conduct cost-benefit and economic impact analyses.)

3. What steps are being taken to ensure that all empirical data and economic analyses submitted by commenters are thoroughly considered before a final rule is adopted.

4. What steps are being taken to ensure that the respective agency is acting in coordination with other agencies charged with adopting related rules? (How is this coordinating being established?)

5. Given the importance of rigorous cost-benefit and economic impact analyses and the need for due consideration of public comments, would additional time for adoption of the Dodd-Frank Act rules improve the respective agency's rulemaking process and the substance of its final rules?

Perfect Storm - Exhibit 2: SBA Office of Advocacy

The SBA Office of Advocacy has written not one, but two letters to the FRB, expressing concern that the "Federal Reserve has not analyzed properly the full economic impact of the proposal on small entities as required by the Regulatory Flexibility Act (RFA)" and recommending that the FRB prepare an initial regulatory flexibility analysis (IRFA).

The result of the first letter, dated January 13, 2011, brought forth from the FRB a "compliance guide" on January 26, 2011.

I put that FRB issuance in quotes, because (as previously noted) it is 'inadequate, incomplete, and regurgitates most features of the "already known" aspects of the Regulation Z final rule amendments affecting loan officer compensation.' Best as I can tell, the "compliance guide" seemed meant to be a rush-job response to SBA's January 13, 2011 letter. In other words, this "compliance guide" is 'a transparent attempt to satisfy a regulatory requirement, though the dubious result adds little to an overall resolution.'

In response to the FRB's "compliance guide," the SBA issued a second letter on January 26, 2011 to the FRB, noting specifically that the "guide may not meet the requirements of the Small Business Regulatory Enforcement Fairness Act (SBREFA)." The SBA letter points up the flaws in the "compliance guide," suggests that revisions should be made to it, and requests postponement.

The FRB's response to the SBA's second letter is, essentially, silence.

Perfect Storm - Exhibit 3: Lawsuits and Consternation

Several industry groups have expressed an intention to sue the FRB, or pursue some form of judicial recourse, with the aim of preventing implementation of the loan officer compensation rule on April 1, 2011. As but one example, the National Association of Independent Housing Professionals (NAIHP) is threatening to sue the FRB within the next few days. NAIHP has invited the NAMB to join them in their suit against the FRB. 

According to a statement posted on the NAIHP website, the organization has been preparing legal action against the FRB for almost 2 months. Marc Savitt, the organization's President, states that preparation for their lawsuit has included "interviewing law firms, lining up expert witnesses, research, countless hours of planning and most importantly, raising funds."

In December, the Mortgage Bankers Association (MBA) sent a 19 page, carefully written and comprehensive letter to the FRB's Ben Bernanke  and Sandra F. Braunstein of its Consumer and Community Affairs Division. Under the rubric of "Questions on Federal Reserve Loan Originator Compensation Rule," the MBA lists 42 (sic) topics, plus sub-topics, of concern, confusion, and uncertainty, mixed with requests for clarity, interpretive guidance, and statutory support.

The Impact Mortgage Management Advocacy & Advisory Group (IMMAAG) has been very involved in seeking to "delay implementation until the appropriate impact studies have been concluded "or at least delay implementation to allow for a 'real' guide to be published and to allow the industry to absorb it and get questions answered."

The National Association of Mortgage Brokers (NAMB) has weighed in mightily and has intimated their interest in pursuing a legal remedy if nothing else will work. The NAMB is also threatening now to take "legal action." (Video)

In January, Michael J. D'Alonzo, President of the NAMB sent a letter to the FRB's Bernanke and Braunstein, requesting a delay in implementation of the loan officer compensation requirements, based in part on alleging that the FRB "has no legal basis for treating mortgage broker companies differently than other firms  carrying out the same or substantially similar business operations" and expressly seeking "clarification as to why the Rule permits  one class of mortgage market participants to: (1) receive incentive compensation based upon the type of loan originated; (2)  reduce their own compensation or income in order to capture more business; and (3) remain exempt from restrictions and  prohibitions set forth in the Rule, while other classes of market participants are held to significantly different standards."

Perfect Storm or Safe Harbor

The new loan officer compensation requirements have produced a plethora of webinars, lectures, training videos, questionnaires, surveys, so-called automated solutions, breakout sessions, magazine and news articles - a virtual cottage industry of Google Ads proclaiming "End-to-end mortgage automation solution for bankers and lenders," and "Confused About Dodd-Frank Changes? Sign Up For Onsite/Webinar Training."

In many of the aforementioned venues, speculation is a proxy for regulatory fact. Having a famous speaker or bigwig compliance professional opining on uninterpreted and unclarified TILA statutes makes me uneasy. There just is no replacement for regulatory guidance. Period!

Here's the reality: the largest loan originators and creditors will fend for themselves in this de facto unregulated environment, and all others will fall in line, unless and until the FRB provides clarification or delays implementation. Otherwise, the notion that the large originators get to make the interpretation of federal statutes, in the absence of the FRB interpreting them concisely, unambiguously, and cogently, is all a bit too Darwinian for my taste!

This is precisely why FRB regulations are promulgated: to assure a stable market and to avoid large companies determining for all the other companies what the FRB means. Furthermore, impact of the new loan officer compensation rules on the industry is a fundamental feature of any such foundational change to the residential real estate finance market. How is it even conceivable that such a change can be implemented without comprehensive impact studies required by federal statutes?

This is not a wave, but a tsunami of confusion with no safe harbor in sight - yet!

I am not a prophet, but betting on a delay seems like a good bet!

Be prepared to implement the loan officer compensation rules on April 1, 2011 - and be sure to consult competent compliance professionals for guidance - even if this dynamic environment continues to cause confusion and ambiguity. But, in the absence of the FRB adequately responding to its role in this debacle it is also wise to do what you can to stand up for the greater good of all market participants.

What do you think?

I would welcome your comments.

Please feel free to email me or leave your comments below.

Fannie & Freddie: Administration To "Wind Them Down"

Today, the Obama Administration has delivered a 32-page report to Congress that outlines plans to "wind down Fannie Mae and Freddie Mac and shrink the government's current footprint in housing finance on a responsible timeline."

Released jointly through the Treasury and HUD, it is entitled Reforming America's Housing Finance Market - A Report to Congress, February 2011, the report is meant to lay out reforms to continue fixing the "fundamental flaws in the mortgage market" through stronger consumer protection, increased transparency for investors, improved underwriting standards, and other critical measures. 

It provides guidelines to provide "targeted and transparent support to creditworthy but underserved families" that want to own their own home, as well as affordable rental options.

We will be analyzing the various policy suggestions in this report and publish an outline in the near future, especially as it affects residential mortgage compliance.

Overview of Report

1. Wind Down Fannie Mae and Freddie Mac and Help Bring Private Capital Back to the Market.

Phasing in Increased Pricing at Fannie Mae and Freddie Mac to Make Room for Private Capital, Level the Playing Field.

Reducing Conforming Loan Limits.

Phasing in 10 Percent Down Payment Requirement.

Winding Down Fannie Mae and Freddie Mac's Investment Portfolios.

Returning Federal Housing Administration (FHA) to its Traditional Role.

2. Fix the Fundamental Flaws in the Mortgage Market.

Helping Consumers Avoid Unfair Practices and Make Informed Decisions About Mortgages.

Increasing Accountability and Transparency in the Securitization Process:

Creating a More Stable Mortgage Market.

Servicing and Foreclosure Processes.

Forming a New Task Force on Coordinating and Consolidating Existing Housing Finance Agencies.

3. Better Target the Government's Support for Affordable Housing.

Reforming and Strengthening the FHA.

Rebalancing the Housing policy and Strengthening Support for Affordable Rental Housing.

Ensuring that Capital is Available to Credit-worthy Borrowers in All Communities, Including Rural Areas, Economically Distressed Regions, and Low-income Communities.

Supporting a Dedicated Funding Source for Targeted Access and Affordability Initiatives.

4. Longer-Term Reform Choices.

Visit Library

Obama Administration Plan Provides Path Forward for Reforming America's Housing Finance Market, Winding down Fannie Mae and Freddie Mac
Press Release
Treasury, 2/11/11

Reforming America's Housing Finance Market - A Report to Congress
February 2011
Treasury and HUD, 2/11/11

The Principal Reduction Alternative

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions. He is the President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

About a half million permanent modifications have gone through HAMP, and 1.7 million trial modifications have been offered, even though the Obama Administration promised HAMP would assist three to four million homeowners. Anecdotally and statistically HAMP has failed.

RealtyTrac reports 2.9 million homes were in foreclosure in 2010, and 2.8 million in 2009, and 2.3 million in 2008. Furthermore, 2011 will see a 20% increase in foreclosure filings - that's above the 3 million mark! As to repossessions: approximately 2,800,000 since 2008, and still growing.

Is there a more effective way to prevent foreclosures?

HAMP - Problem or Solution?

Those who have been following our Newsletters already know that I have been highly critical of the boondoggle known as the Home Affordable Modification Program (HAMP).

Here's just a few selections from our Archive:

• HAMP: "Continues to Struggle"
• HAMP: Continues Downward Trend
• April Loan Modification Report: Is HAMP Failing?

Verdict of SIGTARP

Contrasting the RealtyTrac data with HAMP statistics, the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) states in a report issued on January 26, 2011:

"The number of permanent mortgage modifications under HAMP remains anemic - there were just 522,000 ongoing permanent modifications as of December 31, 2010, with approximately 238,000 of those funded by and attributable to TARP. The remaining were funded outside of TARP by the GSEs. A combined total of more than 792,000 trial and permanent modifications have been canceled, with more than 152,000 trial modification still in limbo. These permanent modification numbers pale in comparison not only to foreclosure filings, but also to Treasury's initial prediction that HAMP would 'help up to 3 to 4 million at-risk homeowners avoid foreclosure' by reducing monthly payments to sustainable levels." (My Emphasis)

An Alternative

In a brief, but very concisely worded White Paper, entitled Principal Reduction Modification Math - A Report by Rick Rogers, JD/MBA, a compelling case is made for the fact that lenders will receive far more value from principal reduction modifications than from other mortgage modifications. The paper is fairly technical, but well worth reading. Rick's practice is devoted to foreclosure, mortgage default, and related matters, and he is an expert in Net Present Value (NPV) comparative analysis. Rick has kindly supported my wish to inform you of his insights.

You can download Rick's White Paper from the HAMP section of our Library.

First just a word about the HAMP program itself. There are several moving parts to the HAMP eligibility program.  

I will name a few significant aspects.

• NPV - the acronym for Net Present Value, when we've extricated the math and algorithm basics - is simply a calculation to decide if the lender is in a better profit position by approving a modification or would have a higher profit margin by foreclosing. It is part of HAMP procedures.
• Plus, the so-called waterfall process, which is really just a step-by-step analytical tool used for HAMP loan workouts. It consists of a series of calculations; however, in this case using such parameters as the gross monthly income, percentage of that gross income used to generate a target monthly payment, and so forth.
• Servicers evaluating HAMP modifications derive a mark to market loan to value (MTM-LTV) ratio on any loan greater than 115%. If so, a principal reduction then becomes available to reducing monthly payments to the eligible 31% of the borrower's gross income.
• Some generic rules: to get to the eligible 31% of gross income servicers reduce the interest rate, extend the loan term, even provide principal forbearance, but only use principal reduction as a last resort.

Nevertheless, these and certain other criteria are supposed to lead to successful permanent modifications based, among other things, on lowering the interest rate, extending the loan term, and/or reducing the loan balance until the eligible target payment is reached.

This White Paper asserts that the the re-default rate - the rate during the 12 months immediately following the modification - is the "single most important factor" when comparing the NPV of a standard Home Affordable Modification Program (HAMP) with the   Principal Reduction Alternative HAMP (PRA HAMP) modifications.

The comparative analysis offered indicates that the more effectual means to preventing foreclosure is not through the standard HAMP but through the PRA HAMP program, because PRA HAMP not only includes the above-outlined HAMP criteria but also specifically permits the reduction of principal. However, PRA HAMP is optional and lenders determine whether or not to implement its principal reduction feature.

As the White Paper affirmatively states:

"Lenders will receive far more value from Principal Reduction modifications than from other mortgage modifications."

FRB Report

Rick cites a recent Federal Reserve Bank of New York Staff Report (FRB Report), entitled Second Chances: Subprime Mortgage Modification and Re-Default , that serves to support the findings that "principal reduction modifications were included in a sufficient number for the authors [of the FRB Report] to state the following conclusion in the Abstract:  '... the re-default rate declines relatively more when the payment reduction is achieved through principal forgiveness as opposed to lower interest rates.'" 

Furthermore, Rick culls the following conclusion from page 30 of the FRB Report:

"Restoring the borrower's incentive to pay in this way [referring to principal reduction] nearly quadruples the reduction in re-default rates achieved by payment reductions through interest rate modifications and term extensions alone."

Put another way: in many instances, principal reduction through PRA HAMP modalities is a more effective foreclosure prevention solution than just reducing the mortgage interest rate along with the other standard HAMP modalities.

And by what ratio? The White Paper points out that "the FRB Report suggests 4 of every 10 standard HAMP modifications will fail, while only about 1 in 10 PRA HAMP modifications will fail."

Here is one of several suggestions offered in this White Paper:

"Consistent with the HAMP concept, a PRA HAMP modification should be mandatory for participating Lenders whenever its NPV exceeds that of both the standard HAMP modification and the "No Modification" alternatives."

Principal Reduction Alternative

Principal reduction is surely a viable means to preventing foreclosure through the PRA HAMP procedures, so it is hard to fathom why the Obama Administration continues to advance dubious claims of success relating to the HAMP program, without further encouraging lenders and servicers to make more use of PRA HAMP.
As the aforementioned SIGTARP report states:

"Treasury's central foreclosure prevention effort designed to preserve that goal [of 'preserving homeownership'] - the Home Affordable Modification Program (HAMP) - has been beset by problems from the outset and, despite frequent retooling, continues to fall dramatically short of any meaningful standard of success." (My emphasis)

The Treasury's most recent Press Release about the HAMP "Scorecard" has this rosy and promising subtitle: "New Making Home Affordable data reveals mortgage help reaching struggling middle class, underwater and minority homeowners."

Political temporizing and vapid Press Releases are not helpful. The HAMP program is a failure, plain and simple.

Dressing HAMP up with fancy statistics and glowing pronouncements can't be convincing to those homeowners who would be better served by more aggressive and effective foreclosure prevention methodologies. Facts are stubborn things, and can't be wished away by the Obama Administration claiming that HAMP works for the "middle class, underwater and minority homeowners" - when, all the while, this government program clearly does no such thing for most of them. HAMP may be "reaching" these mortgagors, but it's really not helping them very much!

It seems to me that principal reduction through PRA HAMP should be more fully implemented and supported.

I'll give Rick Rogers the last word on the potential results of the principal reduction alternative:

"Lenders will achieve far greater financial benefits than with any current modification program, and borrowers will have a fighting chance to regain equity and security in their home."

What do you think?

I would welcome your comments. Please feel free to email me at any time.

Housing Finance Conference: A Case of Extremes

by Jonathan Foxx

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group, the first full-service, mortgage risk management firm in the country.

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Yesterday I went to the Conference on the Future of Housing Finance, held in DC, and hosted by the Treasury. Washington, DC this time of year can be brutally hot and humid - and yesterday was no exception - but the air conditioned conference rooms did little to keep me from getting hot around the collar over the temporizing and equivocating that went on. I guess if you're into photo ops, political peacock preening, media hype, and assorted horse and pony show tactics, it could be considered an entertaining way to spend the day.

But all is not lost. There were some interesting and timely suggestions.

Of course, I was glad to meet friends and acquaintances. But this was not a social event; it was a deadly serious attempt at understanding the deficiencies of the housing finance system, with the goal of seeking ways to prevent future crises. Maybe it's somewhat naive, but I actually expected more from the gathering of such a prestigious and experienced group of industry people, some of whom I have worked with over the years and do admire. There were two large group sessions and several break-out sessions. Sometimes, though, too many powerful vested interests can ruin a good thing!

I want to share with you some observations about the conference in general and Fannie and Freddie (GSE) in particular. In my previous Commentary, I listed a set of core questions that should be considered in any discussion these days about the GSEs. I did not leave the Conference with a strong sense that these questions were answered, or, in some instances, even considered. But it is a worthwhile exercise to highlight some of the suggestions made and the positions staked out by certain participants, if for no other reason than it lets us know the potential direction things may go in the future.

Secretary Geithner stated that the Administration is going to advocate for "fundamental change." High on that list, it seems to me, is the fate of Fannie Mae and Freddie Mac (GSE). Geithner said, and I quote, "We will not support returning Fannie and Freddie to the role they played before conservatorship, where they took market share from private competitors while enjoying the perception of government support."

Of course, this begs the question by not affirmatively stating that it is the implicit guaranty of the government's support which is (1) factored into secondary market pricing, (2) a determinant of securitization values, and (3) at the core of housing policy for the 75 years of the GSEs' existence. Geithner did say that "the challenge is to make sure that any government guarantee is priced to cover the risk of losses and structured to minimize taxpayer exposure." But I find this view to be an equivocation, because it does not adequately consider actual market forces. It is also an indication of the difficulties in harmonizing these competing interests.

Michael Heid, co-president of Wells Fargo Home Mortgage, realizes the central role the GSEs play in establishing a market. In his view, "the maximum use of private capital is essential, but we also believe that an explicit government guarantee will be required to ensure that there's reliable flow of mortgage credit." Spoken like a true mortgage banker!

One suggestion - made by Bill Gross, co-founder of Pacific Investment Management Co. (PIMCO), the world's biggest bond fund - was for the government to provide a "new refinancing program" for GSE mortgages. In this view, the refinance becomes a stimulus to the tune of $60 billion and perhaps an increase of 10% in housing prices. An interesting suggestion. Based on my conversations with some pretty savvy conference participants, it's not going to happen. In my view, this is clearly a position that suggests much greater government involvement.

Mark Zandi, the Chief Economist of Moody's, was a panelist. He took an odd middle-of-the-road view between the extremes of privatizing most aspects of housing finance and nationalization. He pointed to government subsidies, such as the mortgage interest tax deduction, and said that the housing market is "over subsidized." So, he wants to reduce or eliminate some subsidies, while also looking to the government to play a "large role." Is it me, or does anybody else find a contradiction here?

Next to me sat an old friend and client, whose firm handles MBS trading in significant volume. He leaned over to me while Zandi was speaking and said, "do they have any clue, when they talk like this, that this extreme thinking of nationalizing versus privatizing is going to be priced into the market?" We met later in a break-out session, and he was still shaking his head.

On the extreme end of privatizing, Alex Pollack, of the American Enterprise Institute, would like government to be removed from support of housing finance, or so it seems, except for specific programs related to affordable banking such as those available through HUD. Compare that to the suggestion of panelist Lewis Rainieri, the pioneer of securitization and mortgage-backed securities, who noted that there are over 2,000,000 units now on the market and the government should consider supporting rent-to-own financing for qualified borrowers.

I guess things might be more clearly focused if the Dodd-Frank Act had properly addressed the fate of Fannie Mae and Freddie Mac in the first place. But it didn't. Maybe their fate was just too politically hot to handle in that legislation. Maybe having reached 2319 pages, the legislators had to stop somewhere. In any event, the task of saving or re-inventing the GSEs is clearly one of the most important domestic issues now.

In a future Commentary, I will provide my view of the grand plan - or Faustian bargain! - that seems to be emerging about the future structure and role of the GSEs and other housing finance issues.

I would welcome your questions and comments.
Please feel free to email me at any time.

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Lenders Compliance Group is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.

Treasury Announces: Housing Finance Conference

In April 2010, Treasury and HUD issued a set of questions for public comment on the future of the housing finance system, which has received more than 300 responses from a broad cross-section of consumer groups, industry groups, market participants, members of the public, think tanks, and other stakeholders.

These responses are meant to provide input and perspective in the development of a comprehensive reform proposal. Written comments should have been sent to the Treasury for receipt by June 21, 2010 to be assured of consideration.

On August 17, 2010, the Treasury will host a Conference on the Future of Housing Finance in Washington D.C. This event brings together leading academic experts, consumer and community organizations, industry groups, market participants, and other stakeholders for an open discussion about housing finance reform.

If you have any questions about this matter or would like assistance with mortgage compliance, please contact Jonathan Foxx, Managing Director.

Highlights

Questions

1. How should federal housing finance objectives be prioritized in the context of the broader objectives of housing policy?

2. What role should the federal government play in supporting a stable, well-functioning housing finance system and what risks, if any, should the federal government bear in meeting its housing finance objectives?

3. Should the government approach differ across different segments of the market, and if so, how?

4. How should the current organization of the housing finance system be improved?

5. How should the housing finance system support sound market practices?

6. What is the best way for the housing finance system to help ensure consumers are protected from unfair, abusive or deceptive practices?

7. Do housing finance systems in other countries offer insights that can help inform U.S. reform choices?

Visit Library for Issuance

Public Input on Reform of the Housing Finance System
Department of the Treasury and Department of Housing and Urban Development
Federal Register, Vol. 75, No. 77, Notices (4/22/10)

Lenders Compliance Group is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.