Pick an overwhelming percentage, like 80 or 90%. Remember when residential loan production wasn't "that" percent agency? Non-agency loans are still out there and periodically being securitized (just ask Redwood Trust in the jumbo sector), but by most accounts the market is "dislocated." And if you're a large bank, who is flush with cash from deposits, there is certainly no urgency to securitize the product and move it off your books - just keep earning the spread. But here is an update on the non-agency world.

Hey, what would a week in mortgage banking be like without a huge new lawsuit to, once again, cause everyone to wonder about being in this business? In this one, the FDIC is suing the big banks over mortgage debt losses.

In a recent speech Federal Reserve Chairman Bernanke discussed issues impacting the willingness of financial institutions to lend.  Bernanke referred to the Federal Reserve's April 2012 Senior Loan Officer Survey in which most banks indicated their reluctance to accept mortgage applications from borrowers with less-than-perfect records is related to "putback risk"--the risk that a bank might be forced to buy back a defaulted loan if the underwriting or documentation was judged deficient in some way. No surprise there, but the complete text of Bernanke's remarks is accessible here.

The GSE's have gone through, and are undergoing, a tremendous "brain drain" as management and seasoned personnel leaving. (Of course, many talented people remain.) But there is some thinking out in the industry that "we'll get what we pay for" going forward. And say what you will about the industry needing the agencies (and I am a proponent of them in many roles), the uncertainty about Freddie & Fannie's future is impacting the business - but there will no resolution until 2013, after the election. There is no question that Fannie & Freddie set standards in documentation & underwriting, add to liquidity, and give investors stability. Elizabeth Duke, a governor at the Federal Reserve, said the unresolved status of Fannie Mae and Freddie Mac is hurting the housing recovery. "Uncertainty about the future on the part of lenders is inhibiting these investments" in mortgage lending. She also noted that uncertainty over regulations and the outlook for home prices is hindering mortgage lending. This is certainly not a surprise to anyone in the business.

Along those lines, looking back at the agency role 10 years ago, I received this e-mail; "Fannie and Freddie were trying to keep up with Wall Street. Investment banks made the market, created demand (because they had gobs of cash to invest that needed a home), and ended up taking FNMA /FHMC market share simply by expanding the market size with this product. Granted, the Agencies aren't innocent, but Wall Street built the infrastructure, and it was Wall Street who marketed it - they had a huge liquidity appetite to feed.  The GSE's had to follow to maintain share, and because they had to get approval from Congress, they stupidly cloaked their strategy in "Affordable Housing for all" - who wouldn't vote for that? - especially when Congress was not presented with the real risk picture."

The note continues: "I would say that the traditional depository banks such as Chase and Wells and BofA had to try to follow the Street as well. But it was the Wall Street Investment and trading Banks that created the securities and sales infrastructure, product, and demand.  Once the product guidelines were released into the secondary market, it became much cheaper and frictionless to do that product, and have the borrower pay just a little more.....and oh by the way - the Street was paying the originator way up for that product as well, comparable to Fannie & Freddie - especially right at the end, when the Street was desperate for high credit quality product to fluff their securities prospectuses. I do remember specifically a day that my client called me and told me that the Street was bidding up for regular Agency product - not the affordable subprime stuff - and it was more than FNMA/ FHLMC was paying.  I sensed there was something fishy at the time, but I had no idea. That was February 2007, 3 months before the first "no bid" because there was no market for a Subprime pool in May. It's convenient for certain political leaning groups to blame the Agencies (government), just like it's convenient for other political leaning groups to blame the banks.  Both are wrong, and both are right."

And a mortgage bank owner from Oregon wrote, "In reality it was the indirect effects of Fannie and Freddie policy goals that greatly influenced some of the worst decisions the banks and investment companies made.  One example was that by 2002 the GSEs mandated a goal of 50% of all home loans made by lenders had to be made to low and subprime borrows.  These are loans that in the best of times would have made up approx. 15% of the loan pool.  So to stay compliant lenders especially banks were making loans they did not want on their books thus the tremendous expansion of securitization, CDO's."

And now the agencies, and investors in mortgage-backed securities, are grappling with the prospect of principal reductions. Edward DeMarco, the temporary director of the Federal Housing Finance Agency, continues to endure blistering criticism for refusing to allow Fannie and Freddie to pay for large-scale principal reductions for underwater borrowers or to facilitate refinancings for those stuck with high interest rate mortgages.  More

Though officials are mum on specifics, the FHA is readying changes to its controversial condominium rules that have rendered large numbers of units ineligible for low down-payment insured mortgages: .

I have heard dozens of stories about Fannie & Freddie requesting lenders buyback loans for reasons that are not material, and/or did not impact the borrower's failure to make payments. But in listening to the agencies, this is not the case. It is almost as if the sales & management staff work for entirely different organizations from the auditing and QC departments of the agencies, which continue to be well funded and staffed.  Fannie Mae's annual and quarterly SEC reports filed on May 9 included extensive discussion of loan repurchase activity. As of March 31, 2012, Fannie Mae's repurchase requests increased to $12.15 billion, which is significantly higher than the $8.65 billion it requested at the same point last year.

Two other statistics stand out in the filing:  the total amount of cancelled repurchase requests and the amount resolved in ways other than a full repurchase. The first quarter of 2012 saw Fannie Mae cancel $337 million in repurchase requests compared to $227 million over the same period last year. In other words, Fannie Mae cancelled more than half-a-billion dollars in repurchases in just two of the past five quarters. Additionally, during the first quarter of 2012 more than $2.1 billion in repurchase requests were resolved through methods other than a full repurchase, out of $4.47 billion in total resolutions (i.e. almost 55 percent). These alternative methods include loan pricing adjustments, lender corrective action, and negotiated settlements.  Because Fannie Mae reported the face value of the repurchased loan, not the amount of recovery, it is difficult to analyze the effectiveness of such alternatives. But I hear from the owner of a mid-sized mortgage bank: "Even if the agencies throw 10 loans at us to buyback, and we win on all 10 because the logic was flawed or they missed something in the file, we still have to dedicate the resources to win on those 10 - we're being worn down."

Fannie Mae made clear its ongoing intent to "aggressively pursue" repurchase requests, citing the possible need to draw more funds from the Treasury if lenders do not comply with its demands.  Fannie Mae reportedly perceives increased exposure to the institutional risks associated with smaller and non-traditional origination sources because of the reduction in correspondent lenders and mortgage brokers; the filings reflect a conservative valuation of the outstanding repurchase requests to these seller/servicers. This may lessen the incentive for Fannie Mae to collect relative to requests to the largest seller/servicers, as the loss will have already been realized on its books.

This seems to indicate that Fannie Mae may focus on collecting the outstanding requests from its 10 largest customers, who currently account for 74% of the company's single-family book of business. However, as repurchase requests increase the amount of alternative resolutions and outright cancellations will increase proportionally. Either way, the trickle-down practice is in full effect - if anyone thinks that the large aggregators will absorb the losses and spare the smaller lenders, I have a subprime security I'd like to sell them.

In a related topic, one of the big fears of lenders, and servicers, in doing the HARP II loans is mechanical failure. Not the kind where the landing gear doesn't come down, although that would be a decent analogy, but where the borrower doesn't use the same initials on page 37 of the disclosure package, or someone forgot to check the "manufactured home" box during processing. And the loan goes bad. Operational risk has replaced credit risk as the major safety and soundness challenge for national banks, U.S. Comptroller Thomas Curry said in a recent speech. Curry said operational risk, or the risk of loss due to failures of people, processes, systems and external events, is "high and increasing" in light of the complexity of today's banking markets and the technology that supports it. Curry said operational risk is currently at the top of the list of safety and soundness issues for the institutions the OCC supervises. An article in American Banker noted that Curry said operational risks manifest in a number of ways, from inadequate systems and controls that led to servicing mortgage servicing errors, to flawed risk models that create inadequate risk management systems, to lack of controls over relationships with third-party vendors. In particular, Curry said the OCC is finding a rising number of Bank Secrecy Act and anti-money laundering deficiencies in midsize and community banks, including ineffective account monitoring, inadequate tracking of high-risk customers and bulk cash transactions, and lapses in monitoring suspicious activity.
The good news, however, is that the turmoil in Europe has been positive for US mortgage rates for two main reasons. First, economic growth in the region has slowed, which reduces future inflationary pressures. In addition, investors have responded to the uncertainty by shifting to relatively safer assets, including US mortgage-backed securities (MBS). It seems that the only groups complaining about rates are the investors who bought 30-yr mortgages with coupons above 4.5%, or servicers with a lot of this product on their books. (Of course, the hedge against servicing runoff is new production.)

On no news, yesterday's 10-yr T-note closed at 1.74%. With the press still yammering about Facebook's IPO performance, 10AM EST gives us April's Existing Home Sales (4.62M vs. 4.48M last) and May's Richmond Fed Manufacturing index (+11 against +14 prior); at 1PM EST we'll have the Treasury's $35 billion 2-yr note auction. Unfortunately for anyone waiting to lock yesterday, the 10-yr is up to 1.79% and MBS prices are worse .125-.250.

[Into each life a little vacation must fall. Yesterday was spent driving across Nevada and spending the night at the "luxurious" Rustic Inn in Ely, on the way to Moab, Utah for some camping and mountain bike riding in an area with no internet - if that still exists. A few folks are lined up to write, however, at end of the week. Just don't look for many e-mails after tomorrow.]

Several weeks ago the commentary had a fictional story about the evolution of a word using the initials from "Stack High in Transit." It turns out there is a banking tie-in when I received this note:
"My brother receives your commentary and was telling me of his own 'Stack High In Transit' story.t
He worked for a local community bank many years ago where occasionally a loan application would come back from loan committee rejected and marked "NFW".
The compliance officer of the bank hated to see that noted, of course, until my brother told him to think of it as, "No Financial Wherewithal" versus what we all know it meant.