My column from this past weekend, Banks Catch a Break on Bad Mortgages, didn't get Real Money subscribers as riled as I had expected, given that it has major implications for the housing industry, money centers, home builders, mortgage lenders, mortgage insurance providers, and Federal National Mortgage Association (FNMA), and Federal Home Loan Mortgage Corporation (FMCC).
In short, Fannie Mae is now allowing mortgages to be refinanced by borrowers that were not on the original note being refinanced. The result of that change is that purchase transactions can be disguised as refinance transactions.
I'll come back to the implications of that for the capital markets shortly.
Ever since the Lehman-era crisis, there have been battles raging between banks, borrowers, federal legislators, and municipal taxing authorities concerning the treatment of nonperforming residential mortgages.
For some reason I have not been able to determine, the issue and its implications for capital markets has never resonated with investors or the financial media.
At the nadir of the last housing bust, 11% of first-trust residential mortgages in the U.S. were nonperforming, and the average peak-to-trough decline in values was about 35%. Those are horrific numbers -- and worse than what occurred in the 1930s.
In the past decade, only about half of those nonperforming mortgages have been resolved, and yet the economic importance of the issue has still not been appreciated by investors or the financial media, even though accelerating the resolution process and pursuing a strong foundation for the housing sector was the focus of the third round of the Fed's quantitative easing program; which failed.
Commensurate with the quantitative easing actions taken by the Fed, the federal government pursued 12 rounds of loan modification programs that also failed to resolve the nonperforming mortgage issue.
The frustration with these failures gave rise to the pursuit of eminent domain by local real estate taxing authorities, which I last addressed the status of last summer in the column, Report Turns Up the Heat on Banks.
With the federal government's loan-modification programs being terminated at the end of this year, the issue of how to resolve the legacy nonperforming mortgages being carried by the money-center banks is set to become an issue for all stakeholders - including the bank regulators, which have so far ignored the issue.
Maybe that will provide the catalyst needed to draw attention to the issue by investors and the media.
Whether it does or not though, I believe it is logical to conclude that the recent underwriting guideline change by Fannie Mae is indicative of recognition of the urgency of the situation, and is the result of a coordinated effort with the banks to resolve it before the regulators feel compelled to impose a resolution process on the banks, or the municipal taxing authorities begin winning the legal battle on eminent domain.
If the new Fannie Mae guideline is not rescinded, it should result in a surge of refinanced mortgages that transfer the note and responsibility for making payments to new mortgagors, with the previous mortgagors being quitclaimed off of the note and deed or title.
Although there are many implications of this process, the gist of it is that the banks will be provided an outlet to resolve the nonperforming mortgages, Fannie Mae's profits will soar as will those of the mortgage insurance companies and mortgage originators.
This process will almost certainly begin in earnest in the area that is most acutely affected by nonperforming mortgages: Southern California.
If successful there, it will expand quickly to the rest of the urban coastal regions.
This will also prove to be a boon to the investors in Fannie Mae and Freddie Mac that are pursuing a legal case to claw back ownership and profit distributions in the companies from the Treasury.
The money centers most positively affected by this process, in descending order based on the dollar value of their carried nonperforming mortgages, will be Wells Fargo (WFC), Bank of America (BAC), JPMorgan Chase (JPM), and Citigroup (C).
This should also prove to be very beneficial for the mortgage insurance providers, Essent Group (ESNT), Radian Group (RDN), MGIC Investment (MTG), and Genworth Financial (GNW).
The resulting increase in new mortgage-backed securities made available by this should be beneficial to the all of the agency mortgage REIT's too: Annaly Capital Management (NLY), PennyMac Mortgage Investment Trust (PMT), Chimera Investment (CIM), American Capital Agency (AGNC), CYS Investments (CYS), and Capstead Mortgage (CMO).
The sector most negatively impacted by it will be the home builders -- as buyer interest is diverted away from them.
