Before we look at the report a bit of background explanation is required.
Loan quality is categorized according to key credit risk characteristics. For decades Fannie and Freddie (GSEs) operated under "plain vanilla" underwriting guidelines. That meant that from an investment / risk standpoint one GSE loan was pretty much akin to another. Then in the late 1990s the GSEs transitioned to a Basking-Robbins'-31-flavors approach to underwriting as guidelines were expanded to define a greater variety of acceptable risks, which in turn led to a stratification of loans by product type and risk class. Here the concept of risk-layering was employed to recognize multiple risk factors as may exist among the variety of loan flavors within the GSEs' loan portfolios.
The good news today in the referenced report is not in the formulations, or how many basis points are being charged in guarantee fees. It is to be found in the statistics the report analyzes.
About 20 pages into the report are found tables listing statistics on the risk characteristics of new loans originated over the past four years. First, a profile of loans by product type and risk class shows the following positives signs:
- significant increase in 15 year mortgages;
- dramatic improvement in credit score quality;
- substantially higher equity position (lower LTV).
Next is a chart profiling loans based on layered risk factors:
- No Risk Layering originations are up;
- Cash Out Refis are down;
- Decrease in Subordinate Financing;
- Low-doc and Interest-only loans all but eliminated;
- Increase in HARP refinances.
The increase in HARP, Home Affordable Refinance Program, refinances is a positive in that those loans are replacing higher-cost loans for at-risk borrowers, greatly reducing the likelihood of a future default.
From a consumer standpoint these statistics describe borrowers who are better qualified and increasingly conservative. Such a trend is good news for the housing market already overstocked with REO and distressed homeowners. Though the economic challenges of high unemployment and limited business growth continue, perhaps we have were a sign that the overall landscape is leveling a bit from a default perspective.
From the investor perspective more good news. There is consensus that the Baskin-Robbins-style underwriting of the prior decade played a significant role in the problems at Fannie and Freddie. Hindsight is 20/20 and we now know that offering only "plain-vanilla" was key to the long-term stability of the GSEs.
In the 1970s "foreign cars" became increasingly popular as the American car-buyer became increasingly dissatisfied with the poor quality of domestic cars. Eventually US car-makers got the message, retooled and made improvements. Now it looks as if a portion of the US financial sector is heeding a similar message. The indicators contained in the referenced report point to an improvement in overall loan quality, with greater security and reduced risk. So perhaps just like Ford with its 1980's slogan "Where quality is Job #1", Fannie and Freddie have retooled their production lines.
From the investor perspective more good news. There is consensus that the Baskin-Robbins-style underwriting of the prior decade played a significant role in the problems at Fannie and Freddie. Hindsight is 20/20 and we now know that offering only "plain-vanilla" was key to the long-term stability of the GSEs.
In the 1970s "foreign cars" became increasingly popular as the American car-buyer became increasingly dissatisfied with the poor quality of domestic cars. Eventually US car-makers got the message, retooled and made improvements. Now it looks as if a portion of the US financial sector is heeding a similar message. The indicators contained in the referenced report point to an improvement in overall loan quality, with greater security and reduced risk. So perhaps just like Ford with its 1980's slogan "Where quality is Job #1", Fannie and Freddie have retooled their production lines.
Returning confidence to investment markets is badly needed. Let's hope that Fannie and Freddie can emulate Ford in this too, that they stabilizeg financially without further government bailout.
