The Wall Street Journal had a story posted on Sep 16 where the authors, Ben Eisen and Telos Demos, write about how the big banks are once again getting interested in creating new Mortgage Backed Securities (MBS) for sale to investors as was done prior to 2008 and the Housing Crisis. The writers allude to the “wind down” of Fannie and Freddie as the reasoning behind this move. Unfortunately, the writers miss the “big picture.”
Since 2008, there have been few MBS offerings made. Most of these have been done through Sequoia Mortgage Trust and a handful of other companies. In 2019, the total amount of new MBS issued was about $50 billion, a far cry from the $1 trillion yearly offered prior to 2008.
The Sequoia mortgages being issued generally fall under the umbrella of “Non-Qualified” mortgages as I have written about previously. These are mortgages that do not qualify for purchase by Fannie, Freddie, or guarantee by the VA or FHA.
The general characteristics of the Sequoia Mortgage MBS pools are the following:
- Mortgage balances above the Fannie/Freddie limits.
- Very Good Credit
- Low Loan to Value
- Good Debt to Income Ratios and verified income.
These are loans that would likely never go into default even in times of crisis.
What the banks are looking at now with new MBS offerings is something entirely different than what Sequoia has been promoting. Just looking at the reasons why the banks are getting involved reveals their thinking.
Beginning Jan 1, 2021, the Safe Harbor Exemption for the Qualified Mortgage will expire. No longer will banks be able to sell to Fannie or Freddie any loan that they would purchase. Instead, banks will have to pay attention to each loan’s Debt to Income Ratio and Ability to Pay of the borrower. The days of selling 50% Debt Ratio loans to the GSE’s will end and banks will have to pay attention to the maximum 43% Debt Ratios under the Qualified Mortgage.
Loans above a 43% Debt Ratio will have greater risk and will require greater scrutiny and consideration due to the legal liability that will exist after Jan 1, 2021. The result will be fewer loans purchased by the GSEs and fewer loans funded.
To counter the drop in mortgage lending, the banks and Wall Street will apparently result to creating new pools of Mortgage Backed Securities for sale to investors. The new pools of mortgages will have loans of far greater risk of default and liability than of current loans being originated and sold to the GSEs. And since they are not “Qualified Mortgages”, the loans can have higher interest rates and restricted loan terms not allowed by the Qualified Mortgage rule.
The banks will be clever about how they form the new MBS pools. They will combine both Qualified Mortgages and Non-Qualified Mortgages to form a new pool. Most of the mortgages will be Qualified Mortgages with some riskier loans scattered in among the QM loans. This will allow the MBS pools to maintain AAA ratings.
As time goes on, just like the last time, the banks will begin to get more creative in how they form the pools, allowing more and more riskier loans to be placed into any one loan. If not careful, a repeat of 2008 could occur.
Though the banks will be putting the loans into MBS pools, unlike the last time, there will be much greater liability in the event that loans default. The Dodd Frank Act created a Duty of Care by the loan originator to the borrower. If a loan defaults, then the borrower is more able to engage in litigation to get redress for losses from loan originator negligence or malfeasance.
In my next post, I will detail the effects that the Safe Harbor has had on mortgage lending and who have benefited the most.