This is a proposal for the State of Texas to sponsor the creation of a standalone 501(c)(3) nonprofit mortgage securitization corporation for the primary purpose of purchasing Texas originated mortgage loans, securitizing them into pools of prime quality mortgage-backed securities (MBS) and selling the securities to long term investors around the world to ensure the availability and affordability of home mortgage loans for Texas home buyers for generations to come.
The goal is to establish a securitization conduit for mortgage financing that will never use or risk taxpayer funds once it’s up and running by structuring its business model to rely and build upon cash reserves (a Guaranty Reserve Fund) that grow larger every year as opposed to the current models that use leverage, debt, and a taxpayer promise that investors will be repaid.
It only makes sense that we should install a permanent mechanism that will support and enhance Texas property values since our schools and local governments are funded primarily by property tax revenues. Our dependence and reliance on Washington and/or Wall Street for this function is clearly detrimental to Texas real estate markets and the Texas economy.
It will need to be large in order to achieve the economies of scale necessary to compete in the global market place. The low hanging fruit for funding its start-up and operating capital is the National Settlement between the states and the Big Banks over foreclosure practices. Texas is receiving $428 million from the settlement of which we’re still owed about $300 million. We could put $170 million in its Guaranty Reserve Fund, $100 million in operating capital to secure up to $1 billion to finance its loan purchases, and the remaining $30 million used for building and staffing the organization. The Texas Enterprise Fund and/or Rainy Day Fund are also possible start-up funding sources. Because of its nonprofit status, additional funding can be obtained from tax deductible contributions by Realtors, builders, financial institutions, and Texas homeowners. At the very least, even if no funding is available, we should create the institution on paper in case of emergency.
Financing of its operations can come from a variety of sources, ranging from a consortium of Texas banks, to capital markets (Wall Street), private equity firms, the U.S. Department of Treasury and even a line of credit from the Federal Reserve. Historically, institutions can borrow at a 10:1 capitalization ratio with little to no difficulty.
The one remaining question is large MBS investor interest and appetite for these securities as described. MBS investors prefer to avoid Geographic Concentration of Risk. However, prime quality Mortgage-Backed Securities underwritten to traditionally responsible standards and loan terms backed by an ever growing Guaranty Reserve Fund to assure investors will always be repaid will surely be viewed as having an extra layer of safety to offset the risk. I’ve spoken with several smaller MBS investors, and they are extremely interested in the concept of MBS with a cash guarantee.
In Texas, there is a direct relationship between mortgage finance and public school funding
• As a result of the 2008 financial crisis, non-conforming (or Jumbo) home mortgage financing disappeared. Washington recognized the need to fill the gap, so they quickly created a Jumbo Conforming category with a maximum amount of $729,750 for Conventional and FHA mortgages in designated “high cost” areas mainly on the east and west coasts. However, Texas was passed over, and our maximum conforming loan amount remained at $417,000 and our FHA maximum amount was increased to just over $288,000. (Note: The maximum Conventional Jumbo conforming amount has since been reduced to $625,500).
• Subsequently, home values in Texas in the $500,000 to $1,000,000 price range collapsed. According to the Travis Central Appraisal District, assessed values in this range fell by $1,715,404,678 or 13.27% (from $12.93 billion to $11.214 billion) between 2009 and 2010. At an average of 1.2% ISD tax rate, TCAD school districts lost approximately $20.5 million in revenues. Multiply this effect by all of the major metropolitan areas in Texas and it’s clear we’ve suffered substantial losses.
• Jumbo financing has returned, but only with a minimum 20% down payment. Second lien lenders have since filled the void by increasing their maximum loan amounts to as much as $500,000, but at higher interest rates. Creating our own smaller clone of Fannie Mae with a conforming limit of $417,000 and a Jumbo conforming limit of $625,500 with a minimum 10% down payment will substantially reinvigorate demand in the $500k to $1 million price range, supporting higher values in this range and increasing property tax revenues. For example, on a sales price of $695,000, it is considerably easier for more home buyers to put down $69,500 (10%) than to put down $139,000 (20%) which is currently required.
• With our dependence on the Washington monopoly for mortgage financing and our reliance on property tax revenues for school and local government funding, we are extremely vulnerable to what happens in Washington. In late 2010 President Obama signed into law a .20% increase on all government mortgage guarantee fees to offset the payroll tax cut. The FHFA announced an additional .10% increase in Fannie Mae and Freddie Mac guarantee fees effective December 1st, 2012 to “move Fannie Mae and Freddie Mac pricing closer to the level one might expect to see if mortgage credit risk was borne solely by private capital.” They also announced they will begin increasing down payment requirements and raising credit score requirements. In other words, Washington is raising the cost of mortgage financing until Wall Street sees enough profit to take over the monopoly. Higher mortgage finance costs, larger down payments and higher credit score requirements will hurt our real estate values and property tax revenues. Just like our electrical grid, having our own statewide MBS securitization firm will insulate us from what happens in the rest of the country.
• Creating our own MBS firm with a Conforming limit of $417,000 with 5% down and a Jumbo Conforming limit of $625,500 with 10% down will stimulate demand in the $500k to $1 million range, increasing assessed values statewide by the billions and property tax revenues by the hundreds of millions of dollars over time. We have the economies of scale, the resources, the expertise, the regulatory infrastructure, and a healthy enough economy and housing market to do this. And as a nonprofit corporation it will keep financing affordable and available while banking hundreds of millions of dollars per year into its Guaranty Reserve Fund. We just need the will to do it.
Form, Function and Purpose of the Proposed
Texas Mortgage Guaranty Corporation (TMGC)
Description of Purpose – As a 501(c)(3) Non-Profit Corporation, its primary purpose will be to purchase, securitize and sell pools of agency eligible mortgage loans to institutional investors in the Mortgage-Backed Securities (MBS) secondary market. Mortgage loans secured only by Texas properties will be purchased from state-wide mortgage lenders. It will be founded on the principle that the two most important parties in the flow of mortgage money are the borrower and the investor, and that net revenues generated from its operations will be banked and used to guarantee timely repayment of principal and interest to its MBS investors.
With tax exempt status and no need to distribute profits to shareholders and investors, the TMGC substantially reduces and possibly eliminates the moral hazard of private profits and social losses in the mortgage securitization arena. The vast majority of its net operating revenues will be banked into an ever-growing Guaranty Reserve Fund (GRF), with a smaller percentage eventually added to operating capital to gradually reduce the need for financing of its operations. Also, at least 1% of its annual net operating revenue will be dedicated to public financial educations efforts to teach citizens how to become qualified, prime-class mortgage borrowers and home owners.
Since the Federal Government has announced the wind down of Fannie Mae and Freddie Mac over the next 5 to 7 years, and because they will be reducing their maximum loan amounts, increasing their down payment requirements, and raising their fees between now and then, it only makes sense that we should create a securitization firm that protects the state from the additional harm this will cause to Texas real estate markets. Doing so will also have a positive impact on property tax and sales tax revenues, stabilize and support our real estate markets, support and strengthen our regional economy, and normalize our mortgage lending environment.
Description of Loan Products – Initially, loan products will mirror current Fannie Mae and Freddie Mac Agency products and securities with a few key differences outlined later in this document. Products allowed will be prime class fixed and adjustable rate terms ranging from 10 to 30 years in duration. Adjustable Rate Mortgages offered will be 3/1, 5/1 and 7/1 ARMs with 2/2/6 caps on 3/1 ARMs and 5/2/5 caps on 5/1 and 7/1 ARMs and indexed to 1 Year Treasury Securities. Loans will be secured by 1 to 4 family residential properties only. No loans will allow for negative amortization, pre-payment penalties, or interest only features. Multi-Family securitizations may be phased in at a later time if deemed appropriate.
Loan-to-Value ratios (LTV’s) and Combined Loan-to-Value ratios (CLTV’s) will be as follows:
Conforming SFR Owner-Occupied:
95% LTV/CLTV to $417,000
90% LTV/CLTV to $417,000 on all ARMs
Second/Vacation Homes – 90% LTV
2-4 Unit Owner-Occupied and Investor loan limits will match current Fannie Mae limits
Investor (Non-owner occupied) – 80% LTV 1-2 Unit – 75% LTV 3-4 Unit
Jumbo Conforming SFR Owner Occupied:
90% LTV/CLTV to $625,500
All cash-out/equity loans will be limited to 80% LTV/CLTV
Eventually, a self-insuring, 3% down First Time Home Buyers program will be introduced to compete with FHA, and possibly a zero down VA-type program as well for Military Veterans.
All loans with LTV’s above 80% will require Private Mortgage Insurance (PMI) to assist in restoring investor losses in the event of default. Loan level price adjustments and risk-based pricing will also be used within reason. The above terms will remain the same as Fannie and Freddie wind down.
The Jumbo Conforming terms will possibly require Congressional approval since they are not currently allowed in Texas. However, the lack of available Jumbo financing has decimated Texas property values in the $500k to $1 million price range causing tremendous losses in property tax revenues. We desperately need more affordable and available financing in this range.
Underwriting Philosophy – Technology has been a tremendous benefit to the mortgage industry. However, between 1997 and 2000, a sea change occurred that caused the industry to lose its way. It was decided that software underwriting programs would make the final loan decision on all loans sold to Fannie Mae and Freddie Mac. However, the software shifted risk assessment from the risk of default to the risk of loss, and it assumed real estate values would always go up. The rest is history. This change also removed human accountability for risk-assessment from the system and relegated human underwriters to the role of “validators” of the information required by the software. Sub-Prime and Alt-A lenders quickly followed suit, and before long the risk of default was all but disregarded. This shifted all of the risk of default and loss to the borrower and the investor while all of the “middle-men” benefitted immensely.
Software is a useful underwriting tool, but it can only assess numerical parameters set by its programmers. In the first 7 years of the past decade the parameters were clearly set too broadly and today the parameters are too narrow and inflexible. Software simply cannot properly assess a borrower’s risk of default as well as a human underwriter can, nor can it be held accountable for its results. Therefore, this institution will require that human underwriters have final loan decision responsibility for all loans, along with the authority to override software findings either pro or con with proper justification and documentation.
Borrower income, assets, credit history, debt-to-income ratios, and property appraisals will be required, documented and assessed on every loan by certified underwriters. A borrower’s ability and willingness to repay will be fully assessed. For the previous six decades before the last one, this method of underwriting worked extremely well and resulted in an historical default rate of less than 1%. Underwriting software will continue to be used but only as an underwriting aide.
This institution will be staffed with human underwriters with no less than 15 years of underwriting experience. Underwriters for state-wide lending institutions will be encouraged to call staff underwriters to discuss scenarios and gain assistance with loan decisions.
Underwriting Accountability – All loans will be tracked and monitored. Loans that default within the first 12 months will be flagged and analyzed for fraud, improper underwriting, and unforeseen circumstances. Where improper underwriting is determined, policies will be in place to put underwriters on probation and/or require de-certification if certain default benchmarks are exceeded. Underwriters are much more prudent when they know their job is on the line.
100% Risk Retention – This institution will endeavor to retain 100% of the risk of loss on its securities, but it will also avoid subprime loans entirely. The TMGC will retain specific authority to foreclose on defaulted properties on behalf of the investor. With PMI covering losses above 80% LTV, the vast majority of properties can be liquidated quickly at roughly 85% of their value, allowing TMGC to pay off the entire loan and recoup the costs of foreclosure. Once a property is foreclosed upon, the GRF will be used to bring delinquent payments current and will continue to make monthly payments to the investor until the property is liquidated and the loan is paid in full. Any deficiencies resulting from the liquidation of the property will be covered by the GRF as well. Any excess funds resulting from liquidation will be put back in the GRF.
100% Transparency – By law, a Non-Profit Corporation is required to be transparent in its operations in order to maintain its tax-exempt status. However, this institution will go much further on behalf of investors. It will provide an investor portal where interested investors can view real-time information on the level of its Guaranty Reserve Fund as well as delinquency and default rates, pre-payment speeds, and any other information deemed important to an investor’s decision whether to invest in this firm’s securities. This information will be easier to obtain and maintain if the sister non-profit servicer recommended below is also created.
Geographic Concentration of Risk- Although Texas is currently one of the healthiest real estate markets in the nation and has a large and diverse economy, geographic concentration of risk is still an issue for investors. However, mechanisms will be in place to help mitigate this risk such as increased down payment requirements in particular zip codes or MLS areas when bubbles are detected, and LTV increases to 90% for qualified investors to stimulate sales in areas that are depressed. Otherwise, industry feedback is requested and encouraged to help address this issue when considering how these securities will trade in the secondary market.
Securities and Securitization Volume – Securities offered will be of the simple “pass-through” variety and hopefully traded in the TBA and Specified Pool markets. Texas funds over $35 billion per year in mortgage loans (source: TMBA) and generates an average of $40 billion per year in residential real estate sales (source: Texas MLS). It is anticipated that this company will be able to securitize and sell between $10 billion and $30 billion per year in MBS.
The goal of this institution is to create securities of high enough quality and safety to compete with U.S. Treasury Securities as investments. MBS investor and secondary market participant feedback is requested and encouraged regarding this aspect.
The Guaranty Reserve Fund – Assuming at least 1% gross revenues from delivery and guaranty fees and $12 billion per year in securitizations, this company should easily be able to set aside $100 million per year into its Guaranty Reserve Fund to protect investors from losses. Once the fund reaches appropriate levels as determined by actuaries, excess revenues can be used to increase operating capital and reduce the need for financing. Excess reserves will also be used to support affordable housing/financing goals such as down payment assistance programs, interest rate subsidies, and homebuyer education.
The GRF will be self-funding from securitization operations and will grow stronger every year. Neither state nor federal taxpayer funds will be used or risked to protect investors.
Start-up and Operating Capital – To achieve the necessary economies of scale, it is estimated the TMGC will need to raise a minimum of $100 million in order to borrow up to $1 billion to finance initial securitization operations. Funding can be raised from a variety of sources, ranging from the $428 million owed to Texas from the National Settlement, to industry participants such as Realtors, builders, mortgage professionals, financial institutions, and possibly the State of Texas. Industry feedback is requested and encouraged to address commercial financing options and costs, but the current assumption is that financing can be provided by a consortium of Texas based banks, or capital markets, or the U.S Treasury, or the Federal Reserve.
Legislation – State sponsorship is sought only to reassure investors this institution will be responsibly managed and regulated and to assist with start-up. Texas already has world-class licensing and regulatory infrastructures in place, so proper regulation and oversight is guaranteed. Additionally, carefully crafted legislation will be required (through Joint Resolution) to ensure lawmakers are prevented from accessing the GRF or requiring the TMGC to lower its credit or lending standards. Industry participants need to clearly understand that the State of Texas will explicitly NOT guarantee this entity’s securities against losses. The TMGC will provide an agency guarantee only.
501(c)(3) Tax Exemption Qualifications – Non-Profit Corporations function just like for-profit corporations, but can receive tax-exempt status if they meet at least one of the federal and state qualifications for a non-profit corporation. This company meets at least two of the federal and at least four of the state requirements for non-profit classification.
Federal – The TMGC meets the charitable/benevolent requirement by providing affordable and available mortgage financing for all Texans and assisting with home ownership initiatives. It meets the educational requirement by providing free financial education programs to citizens with an emphasis on achieving prime borrower status and encouraging wealth building through real estate ownership. Every citizen should be taught what it takes to acquire a home and own it free and clear by retirement as part of their quest to achieve economic independence and enjoy the American Dream.
State – The TMGC meets the charitable/benevolent and educational requirements, but it also fulfills two others: Civic and Professional. Since Texas has no state income tax and is primarily dependent on property and sales tax revenues for its operations, it supports a civic mission by supporting real estate values with affordable financing which enhances property tax revenues. It also fulfills the professional requirement by providing responsible lending guidelines and parameters for Texas mortgage lending institutions. Additionally, it provides a secondary market conduit for community banks and credit unions which will help avoid systemic risk issues when interest rates rise.
The TMGC can and should pay its executives market rates for salaries and wages to ensure it will attract and retain talented, experienced industry professionals. Politicians need not apply.
Non-Profit Loan Servicing Corporation – In light of the recent news regarding questionable servicing practices among mortgage loan servicers, it would also make sense to have the state create a sister non-profit servicing company to service the loans securitized. This would enhance the ability to track information regarding delinquencies and pre-payment speeds for investors as well as generate additional revenue. Using its net operating reserves, it could become a valuable resource for individuals who find themselves in need of temporary mortgage help and counseling. If a homeowner suffers an unforeseen circumstance such as a job loss, a medical emergency, a death in the family, a divorce, or any of life’s happenings that cause temporary financial hardships, having a servicer in a position to make one, two or three payments on behalf of the borrower (while adding them to the back-end of the loan) would be a godsend to many and would additionally mitigate the risk of default.
MBS Investor/Secondary Market Participant Feedback Request – I am seeking investor and secondary mortgage market support, input and opinion regarding the viability, liquidity, quality, size of issuance, price/yield, method of dissemination, concentration of risk, financing, and any other helpful feedback to determine the anticipated success of the securities offered by this organization. This business model has the potential to be superior to Fannie Mae, Freddie Mac, or any other government or private market alternative. This business model can also be duplicated by other states or groups of states which will help transition the industry away from the federal government. It’s intended to serve as a replacement for Fannie Mae, Freddie Mac, and possibly Ginnie Mae. It minimizes taxpayer risk, it mitigates risk from profiteers and well-meaning politicians, it protects and strengthens the bond between borrower and investor, it’s 100% transparent, and it grows stronger over time. This is not an attempt to reinvent the wheel; it is an attempt to re-create what used to work quite well with safeguards in place to prevent what went wrong from happening again.
If you support this concept please help spread it around, and if you’re in Texas please forward this to your state lawmakers and ask them to act on it.
Texas Mortgage Banker