Mortgage Banking
August 2009
The chairman of the Federal Deposit Insurance Corporation shares her views on navigating the banking system through the current financial market crisis.
By Robert Stowe England
Sheila C. Bair was sworn in as chairman of the Federal Deposit Insurance Corporation (FDIC) on June 26, 2006, for a five-year term. As FDIC chairman, she has presided over an exceedingly tumultuous period in the nation’s financial sector. She has helped transform the agency with programs that provide temporary liquidity guarantees, increases in deposit insurance limits and systematic mortgage loan-modification relief for troubled borrowers.
Before joining FDIC, she was Dean’s Professor of Financial Regulatory Policy for the Isenberg School of Management at the University of Massachusetts at Amherst from 2002 to 2006. While there, she served on the FDIC’s Advisory Committee on Banking Policy.
Prior to taking the helm at FDIC, Chairman Bair had considerable experience in government. She was assistant secretary for financial institutions at the Department of the Treasury from 2001 to 2002; senior vice president for government relations at the New York Stock Exchange from 1995 to 2000; a commissioner and acting chairman of the Commodity Futures Trading Commission from 1991 to 1995; and research director, deputy counsel and counsel to Senate Majority Leader Robert Dole from 1981 to 1988.
During her FDIC tenure, Bair has received a number of prestigious honors. In 2008, for example, Forbes magazine named her the second-most powerful woman in the world after Germany’s Chancellor Angela Merkel. In 2009, she has been awarded the John F. Kennedy Profile in Courage Award ® – an annual award by the John F. Kennedy Library Foundation made by a bipartisan awards committee, honoring people in public service who exemplify the ideals in John F. Kennedy’s book Profiles in Courage – and was named one of TIME (end) magazine’s “TIME 100” most influential people.
At FDIC she has also championed the creation of the Advisory Committee on Economic Inclusion, research on small-dollar loan programs and the formation of broad-based alliances in regional markets to bring underserved populations into the financial mainstream. She also received in 2009 the Hubert H. Humphrey Civil Rights Award, an award presented annually by the Leadership Conference on Civil Rights to celebrate the legacy for former VP Humphrey, a civil rights champion in 2009.
Bair received a bachelor’s degree from Kansas University, Lawrence, Kansas, and a juris doctorate from Kansas University School of Law.
Mortgage Banking interviewed Chairman Bair in mid-July to get her thoughts about the progress that has been made in addressing the fallout from the financial crisis.
Q: Where do you think we are in addressing the financial crisis that emerged in 2007 and which grew dramatically worse after the failure of Lehman Brothers in September 2008? Broadly speaking, what has been accomplished so far? What remains to be done?
A: Since the financial crisis began, government and industry together have taken extraordinary steps to maintain the stability of our financial system. All of the government measures put in place over the past several months have been taken to restore confidence in the nation’s financial institutions, including a substantial expansion of guarantees for bank liabilities by the FDIC, injections of capital by the Treasury in many institutions both large and small, and Federal Reserve programs to provide liquidity to financial institutions and support the normalization of key credit markets.
These efforts averted serious threats to global financial stability last fall and have contributed to gradual improvement in key credit markets, though many markets remain stressed.
As a result, we’ve moved beyond the liquidity crisis of last year, and we’re cautiously optimistic that the industry as a whole is getting on a better footing. But there is still more pain ahead because of the problems in housing, which is still looking for a bottom. At the FDIC, we’ve aimed our policy initiatives at preventing a destructive overcorrection in housing that could further damage our economy and our financial institutions. While we’ve had to close nonviable institutions (and closings are expected to keep rising into next year), the FDIC and other regulators are working to improve the ability of other institutions to keep making loans to creditworthy borrowers.
Q: One of the largest bank failures you have handled is the one for Indymac, Pasadena, California. Could you give us an update on what is happening with Indymac? To what extent have the loan modifications at Indymac been successful in preventing foreclosures? What has been the re-default rate on the early modifications done with the loans from the Indymac portfolio? Has the re-default rate improved on Indymac’s more recent modifications and what has been key to that performance improvement if one has occurred?
A: On March 19, 2009, all deposits of Indymac Federal Bank FSB were transferred to OneWest Bank FSB [Pasadena, California]. OneWest Bank continues to apply the FDIC loan-modification protocol to all delegated first-lien mortgage loans it services. Through June 24, 19,924 borrowers have accepted the modification offer, returned the appropriate documentation and were approved for modification.
The approval process includes income verification via recent pay stubs and/or tax returns. This is an important step in the modification process, as it minimizes re-default and ensures the affordability standard is uniformly implemented. An additional 1,873 have recently responded to a loan-modification offer and are currently in process. OneWest Bank is currently applying for the Obama Administration’s Home Affordable Refinance Program (HAMP), which is part of the Making Home Affordable effort.
As of April 30, the re-default rate (defined as loans classified as 60 days or more delinquent) for all modified loans was 13.5 percent. Modification activity through April reduced the expected loss given foreclosure by an estimated $525 million.
Modified loan performance has improved significantly since the first modifications were mailed in August. This is attributed to several factors. First, the modification process has become a fully operational business function, with trained loss mitigators and call-center staff, systems for recording and processing modifications, income-documentation processes and an early re-default calling campaign. In addition, the initial population eligible for modification at Indymac was largely populated by seriously delinquent borrowers; this group of borrowers is less likely to perform than borrowers recently entering the delinquency pipeline. Finally, the FDIC loan modification program reduced the target front-end debt-to-income (DTI) ratio from 38 percent to 31 percent.
Given improvements in operations and the characteristics of borrowers receiving loan-modification offers, performance has improved significantly since program inception. Initial modifications had a 60-day delinquency rate of 22.7 percent after three months’ seasoning. This figure declined rapidly in ensuing months to around 14.5 percent. Additionally, the decrease in DTI standard notably improved performance. Loans modified to the 31 percent DTI standard are showing a 60-day delinquent rate of 3.9 percent compared to a 10 percent [rate] for loans modified to the 38 percent DTI standard with similar seasoning.
Q: The Obama administration's Home Affordable Modification Program has been very slow to get off the ground. Why is that? The largest servicers are signed on, so what has been the hold-up in getting more modifications done? Did you think the program you instituted in the wake of the Indymac failure was a better way to go with modifications, and what aspects of that approach were adopted in the Obama administration’s mod plan?
A: Questions on implementing HAMP should be directed to Treasury or the program administrator, Fannie Mae. However, it is worthwhile to note insights gained from the Indymac experience. Implementing a streamlined bulk-modification program is a resource-intensive effort. It requires servicers to change their traditional loss-mitigation strategy from one based on customized loss-mitigation solutions to a standardized modification model.
For example, prior to the first modification offer mailing, the servicer must undertake these lengthy initiatives: train loss mitigator and call-center staff; improve servicing systems to effectively record and report on modification activity: review applicable servicing contracts; determine compliance issues; develop marketing materials; and develop an income-verification process.
Meanwhile, servicers are stretched to capacity managing portfolios with growing numbers of delinquencies and foreclosures. The first-lien HAMP was announced March 4, with the final supplemental directive issued April 6. Modification activity will increase in late summer to early fall as servicers develop the required infrastructure to respond to the volume of distressed borrowers requesting loan modifications.
Q: Have investors been the hang-up in preventing banks from doing more loan modifications? Will the newly enacted safe harbor for servicers to modify loans help overcome that problem and produce a wave of new modification activity?
A: Loan modifications affect the cash waterfall in securitized transactions, causing different concerns for different investor classes. Ultimately the servicer must adhere to the Pooling and Servicing Agreement or other legal document governing the transaction. A servicer’s best defense against criticism or possible litigation is a uniform modification program with clear eligibility guidelines and a rigorous net present value (NPV) test, which compares the estimated value of modification to the estimated loss given foreclosure, to ensure that the modification results in a lower cost.
The HAMP provides this structure and is reinforced by the safe harbor for servicers. While this will encourage modification activity, the largest gains in modification activity will occur once servicers implement HAMP and put in place internal procedures for evaluating and processing loan modifications.
Q: How would you describe the role played by the Temporary Liquidity Guarantee Program [TLGP] in unfreezing many debt markets? Do you think those guarantees need to be extended?
A: The FDIC’s Temporary Liquidity Guarantee Program has helped stabilize the financial markets by providing additional liquidity to institutions. By guaranteeing bank liabilities, TLGP has provided a backstop to business checking accounts and interbank lending, thus helping financial institutions fund themselves so that they can make loans to creditworthy borrowers.
We are now seeing positive signs of recovery in the debt markets, and are working to wind down the program at the end of October. At the end of May, there was approximately $346 billion in outstanding debt guaranteed under the TLGP. Importantly, TLGP debt outstanding has a longer term at issuance compared to debt outstanding at the end of 2008. As of May 31, only 23 percent of the debt outstanding was issued to mature in 180 days or less, compared to 49 percent at year-end 2008. More than two-thirds of debt outstanding--69 percent--was in medium-term notes, compared to 44 percent at year-end.
In another positive sign, several banks have issued debt not guaranteed by the FDIC, including debt with long-term maturities ranging from five to 10 years.
The FDIC has already extended the duration of the TLGP debt guarantee program. The transaction guarantee component continues until Dec. 31, 2009, but we are considering two options for this program. One option is to extend coverage through June 30, 2010, and raise premiums from 10 cents to 25 cents for every $100 of covered deposits. If we choose this extension, banks that currently participate in the program would have the opportunity to opt out before the extended phase begins. The other option is to maintain the current expiration date.
Q: What will it take to revive the jumbo mortgage-backed securities [MBS] market, and should banks be involved in that segment of the market? What regulatory controls need to be put in place for the private jumbo MBS market to function efficiently and safely once again? When do you expect that part of the market to reemerge?
A: For our mortgage finance markets to function efficiently and safely going forward, we need to tighten consumer-protection rules and restore back-to-basics lending practices. The mortgage industry must set strong standards for underwriting, disclosure and data transparency before investors will come back to private mortgage securities.
The complex structures that obscured risk must be abandoned. Efficient markets work on the ability of all market participants to accurately understand and price risk. We need products and processes that are simple and transparent, so that investors, lenders and consumers alike are informed of the risks. And certainly part of the solution will involve a greater level of government oversight and enforcement.
Q: To what extent have expanded deposit guarantees played a role in containing the banking crisis and in restoring confidence in the banking system? Do you think those guarantees need to be extended? Have there been any losses? How much has the FDIC earned from its loan guarantees?
A: The FDIC has expanded deposit guarantees through two actions. The first was taken under the Emergency Economic Stabilization Act of 2008 and applies to all insured depository institutions. It temporarily increased deposit insurance coverage from $100,000 to $250,000. The second action was taken under our Temporary Liquidity Guarantee Program and applies only to those insured depository institutions that choose to opt in to the program. Under TLGP, the FDIC created the Transaction Account Guarantee (TAG) to provide a full guarantee of non-interest-bearing deposit transaction accounts until Dec. 31, 2009.
Both guarantees have contributed importantly to the gradual easing of liquidity strains on our financial institutions and are an integral part of the coordinated effort by the FDIC, the Treasury and the Federal Reserve to address unprecedented disruptions in the credit markets and the resultant inability of financial institutions to fund themselves and make loans to creditworthy borrowers. They are an important element in efforts to move our economy forward.
Though funding conditions have eased somewhat, the temporary increase in deposit insurance coverage to $250,000 has been extended through 2013. The FDIC is considering the potential extension of TAG for an additional six months in order to facilitate an orderly end to the program.
Over 7,100 insured depository institutions are participating in the TAG component of the TLGP, accounting for an estimated $700 billion in expanded coverage. At the time it was developed, there was concern that many account holders might withdraw their uninsured balances from insured depository institutions. TAG was designed to improve public confidence and encourage depositors to leave their large account balances in those institutions. The program has been an important source of stability for banks with large transaction account balances.
Q: The board of directors of the FDIC this spring levied an emergency charge and raised annual premiums. At the time, you stated that the FDIC expects bank failures to cost about $65 billion over the next five years, much of it this year and next. This is in addition to $18 billion in losses last year. Could you update our readers on how many bank failures there have been, and do you still expect losses at around $65 billion? How soon will these new premiums replenish the FDIC reserve fund so that it is again equal to1.15 percent of insured deposits?
A: As of July 14, there have been 53 bank failures so far this year, compared to 25 in all of 2008. We now expect losses to total $70 billion over the next five years but, again, much of these losses are expected in 2009 and 2010. The FDIC imposed a special assessment of 5 basis points on assets minus Tier 1 capital as of June 30, 2009, and will collect this special assessment in September 2009 along with the regular quarterly assessments that were increased this year. We expect the fund to reach 1.15 percent by 2015.
Q: There has been an enormous amount of interest in the legacy loan program to be administered by the FDIC. To the extent that losses on loans have increased since that program was announced, do you still believe it has the potential to remove a significant level of troubled assets from bank balance sheets? How would you describe the level of interest in this program by potential purchasers of those loans? Do you think banks will be willing to participate, given the fact they might not get the prices they would hope to get? When do you now expect to get this program off the ground with the first auction?
A: On June 3, the FDIC formally announced that development of the Legacy Loans Program (LLP) will continue, but that a previously planned pilot sale of assets by open banks would be postponed. Banks have been able to raise capital without having to sell bad assets through the LLP, which reflects renewed investor confidence in our banking system. As a consequence, banks and their supervisors will take additional time to assess the magnitude and timing of troubled assets sales as part of our larger efforts to strengthen the banking sector.
As a next step, the FDIC will test the funding mechanism contemplated by the LLP in a sale of receivership assets this summer. This funding mechanism draws upon concepts successfully employed by the Resolution Trust Corporation in the 1990s, which routinely assisted in the financing of asset sales through responsible use of leverage. [By the time this interview is published, the FDIC is expected to have already solicited] bids for this sale of receivership assets. The FDIC will continue its work on the LLP and will be prepared to offer it in the future as an important tool to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy.
Q: What changes do you think are needed in the regulation of financial institutions? Do you believe that the securitization market for loans should come under great regulatory oversight, given the role mortgage-backed securities and their derivatives have played in creating the credit and banking crises?
A: There are many different types of financial product and service providers. While the banking industry certainly should bear its share of the blame for the current financial crisis, many abusive products and practices originated in the unregulated sectors of the financial marketplace and these firms should be held accountable for their actions as well.
The confidence of consumers and investors in financial markets has been shaken to the core. And it can only be restored with the commitment of financial professionals who insist on the highest possible standards for consumer protection and for safe and sound business practices, in all parts of the industry.
As well, the private mortgage securitization business must be restarted and placed on a sounder footing. At the height of the housing boom, in 2005 and 2006, more than $1 trillion in private residential mortgage-backed securities [RMBS] were issued a year. By the second half of last year, however, that market had virtually shut down. Restarting this vital method of mortgage finance is going to require a great deal of discipline, care and restraint from everybody.
The mortgage industry must set strong standards for underwriting, disclosure and data transparency before investors will come back to private mortgage securities. The complex structures that obscured risk must be abandoned. We need simpler, more standardized deals that everybody can understand, and where performance can be readily analyzed. We need to make sure that incentives are aligned among all parties by making compensation contingent on the long-run performance of the underlying loans.
Q: Do you think leverage requirements should be part of any financial regulatory reform in the United States, regardless of what happens to Basel II capital requirements?
A: Although the intense public debate over Basel II seems like a thing of the distant past, I remain committed to the idea that leverage requirements are important for banks not just in the United States but around the world. By providing capital even when risk-based measures (erroneously, as it turned out) indicate minimal risk, the leverage ratio is a critical part of our overall approach to capital regulation. When we emerge from this crisis, a top priority must be crafting a sound capital framework that helps avoid a repeat of past problems; it should include a leverage ratio.
The Basel Committee is in the process of changing capital rules in a number of areas. There will be improvements. But for most banks, these improvements are unlikely to offset what we see as a capital-lowering bias that is essentially baked into the advanced approach. With the dangers of excessive leverage so clearly demonstrated over the last 18 months, it would be imprudent to determine regulatory capital based solely on the advanced approach.
I strongly believe that global leverage capital requirements are sorely needed. They should apply to all systemically important financial firms, regardless of charter. Unlike the current system, they would set a capital floor for the advanced approach, which would limit excessive leverage in the future.
Q: Do you have any views you would like to share on the future of non-depository independent mortgage bankers and lenders?
A: I think that it is important that we ensure that non-depository independent mortgage bankers and lenders are subject to the same standards and controls as regulated chartered institutions. One of the lessons of the crisis is that we cannot have conflicting standards that put downward competitive pressure on lending standards. The best type of mortgage is one that the borrower can afford, understand and will perform on. That’s common sense that will serve both industry and borrowers.
Q: Finally, would you like to comment on what it has been like to be at the helm of the FDIC in this extraordinary time of financial turmoil?
A: It’s unquestionably been a hectic time at the corporation. Through last fall, there were many late or all-nights, including weekends. What it has demonstrated is how important the FDIC is in times of crisis. This agency was born of a financial crisis and continues to excel in them. The FDIC has extraordinarily hardworking and dedicated staff in every division. Some of the decisions and choices that we have had to make--while sometimes difficult--have proven instrumental to helping to stabilize the financial system. I’m honored and humbled to have had the opportunity to lead the corporation through this period. MB
bio: Robert Stowe England is a freelance writer based in Arlington, Virginia. He can be reached at
Copyright © 2009 Mortgage Banking Magazine
Reprinted by Permission
