DOCUMENT RESUME 00552 - [A0891628] Government National ortgage Association's Secondary Mortgage Market Activities. CED-77-28. March d, 19'7. 56 pF. Staff study by Henry Eschwege, Director, Community and Economic Development Div. Issue Area: Domestic Housing and Community Development: Federal credit Incentives to Stimulate Housing (2104). Contact: Community and Economic Development Div. 3udget Function: Commerce and Transportation: Mortgage Credit and Thrift Insurance (401). Organization Concerned: Department of Housing and Urban Development; Government National Mortgage Association. Congressional Relevance: House Committee on Banking, Currency and Housing; Senate Committee on Banking, Housing and Urbai Affairs. Authority: Housing and Urban Development Act of 1968 (12 U.S.C. 1717). Bmerg'.ncy one Finance Act of 1970, title III (12 U.S.C. 1452 P' seq.). Housing Act of 1954 (12 U.S.C. 1716 et seq.). Emergency Home Purchase Assistance Act of 197el. Emergency Housing Act of 1975. The Government National Mortgage Association participates in the buying and selling of mortgages in the secondary mortgage market. Findings/Conclusions: The Association attempts to accomplish its legislatively assigned missions primarily by: issuing to mortgage originators commitments to purchase mortgages with primarily below-market iDterest rates; purchasing and selling such mortgages; and guaranteeing securities, backed by pools of mortgages, that are issued by approved mortgage originators. Review of the Assoriation's sales activity identified a number of alternatives that rrrant study by the Association because they have potential to increase revenues or otherwise imprcve operations. The sale of Association mortgages directly tc the Federal financing Bank woild allow the Association to adhere to the Office of Management and Budget's imposed outlay ceiling, while it would eliminate the need to sell the mortgage in the private market under unfavorable conditions. Recommendations: The Association might be able to receive a better return on the sale of securities if it sold the securities directly to investors rather than by blocks to syndicates which resell them at a profit. The Associaticns should also consider reducing the amount required for a security issue to an amount less than the present $1 million. (SC) LC 0 i- . STUDY BY THE STAFF OF THE UNITED STA TES GENERAL ACCOUNTING OFFICE Government National Mortgage Association's Secondary Mortga.ge Market Activities This study develops information on the Gov- ernment National Mortgage Aociation's buying and selliig of mortgages in the second- ary mortgage market. It also discusses GAO's report of November 29, 1976, which recom- mended that the Secretary of Housing and Urban Development consider tie desirat ity of alternatives to tt,e present mortgage practices hich night increase revenuessales or otherwise improve operations. CED-77- 28 MAhi 1 3, 1 9 7 7 PREFACE This study was prepared by GAO's Community and Economic Development Division for the Subcommittee on Housing'and Urban Affairs, Senate Committee on Banking, Housing and Urban Affairs. The Subcommittee requested that we develop informa- tion on the Government National Mortgage Association's buying and selling of mortgages in the secondary mortgage market. After testimony was provided to the Committee in September 1976, we made arrangements to issue (1) a report to the Secre- tary ct Housing and Urban Development outlining the areas that need improvement in the Association's secondary mortgage market activities (CED-77-6, Nov. 29, 1976), and 2) a staff study describing the Association's role in the secondary mortgage market. The staff study presents the most current data available at the time of our review but has not been updated to reflect changes that may have taken place since our testimony in September 1976. Henry Eschwege Director, Community and Economic Development Division STUDY BY THE STAFF THE GOVERNMENT NATIONAL MORTGAGE OF THE UNITED STATES ASSOCIATION'S SECONDARY MORTGAGE GENERAL ACCOUNTING OFFICE MARKET ACTIVITIES Department of Housing and Urban Development DIGEST The Housing and Urban Develcoment Act directs the Government National Mortgage Acsociation to parti- cipate in the secondary mortgage market for the purpose of: -- Making mortgage financing available for those Americans unable to obtain adequate housing under established financial programs. -- Retarding or stopping declines in homebuilding and mortgage lending. -- Encouraging mortgage originators to epand their allocation of funds for mortgage investments. -- Attracting nontraditional sources of long-term investment capital to the mort- gage market. The Association attempts to accomplish these missions primarily by -- issuing to mortgage originators commitments to purchase mortgages with primarily belo%-market interest rates; -- purchasing and selling such moLtgages; and -- guaranteeing securities, backed by pools of mortgages, that are issued by approved mortgage originators. (See p. 8.) COMMITMENTS AND PURCHASES A commitment is an agreement by the Government National Mortgage Association to purchase a specific type of mortgage bearing a specified interest rate at a specified price from a mortgage originator. The interest rate specified in the commitment is usually lower than the market interest rate. iear She . Upon removal, the report cover date should be noted hereon. i CED-77-28 Commitments are intended to encourage mortgage originators to make loan commitments which are intended to make to homebuilders it easier for builders to obtain construction financing. The commitment also insures builders that homebuyers can obtain a mort- gage and enables the uilders to advertise the availability of below-market interest rates. Legislation authorizing the Government National Mortgage Association to make commitmenrts and purchase mortgages places a ceiling on the combined amount of commitments and purchases that the Association may have outstanding at any time, which was $20.5 billion as of March 31, 1976. (See p. 10.) The Office of Management and Budget must approve the Association's use of the legislative authority. The Office of Management and Budget determines timing and amount of authority to be released based on requests made to the Association by the Secretary of Housing and Urban Development and the President. The types of mortgages to be purchased are mutually agreed on by the Office of Management and Budget and the Secretary of Housing and Urban Development with recom- mendations from the Government National Mortgage Association. The methods the Association used to satisfy commitments and the amount of commitments each method satisfied during the period JuLy 1, 1972, through March 1, 1976, were: -- The holder of the commitment took action to cancel the commitment or allowed it to expire by not delivering mortgages for purchase by the Association within the specified time period--$.4 billion. -- The obligation under a commitment by the commitment holder or was assumed a third party with the Association paying the difference between the commitment price and current market price at the time of assumption--$6.2 billion. --The Government National Mortgage purchased the mortgages when Association delivered-- $12.1 billion. (See p. 23.) ii SALES OF MORTGAGES AND SECURITIES The Association finances its purchases of mortgages and related operations through borrowings from the Treasury and revenues it receives primarily from proceeds from the sale of mortgages and mortgage-backed securities. During fiscal years 1973-75, the Asso- ciation had revenues of $5.8 billion, of which 75.1 percent ($4.4 billion) came from mortgage and security sales. Through these sales, the Association minimizes its borrowings from the Treasury by substituting private for Federal funding. (See p. 28.) Because the Government National Mortgage Association, as intended by its authorizing legislation, generally purchases mortgages with below-market interest rates at a higher price than private investors are willing to pay, it usually suffers a loss when it sells these mortgages on the private market. Con- sequently, the Association can minimize those losses best by timing its sales to take advantage of the most favorable market conditions. (See p. 29.) The amount and timing of its sales are heavily influenced by the Office of Management and Budget's ceiling on the Association's net outlays (difference between expenditures and revenues), which affect its Treasury borrowings. This net outlay ceiling can place the Association in the position of having to sell mortgages to stay within the outlay ceiling even though losses could possibly be minimized by delaying sales until market conditions improved. In fiscal year 1975, the Office of Management and Budget allowed the Government National Mortgage Association to exceed the ceiling by $1.9 billion in order to avoid excessive losses. (See p. 33.) Between July , 1972, and March 31, 1976, the Association has used a variety of sales methods to dispose of $9.1 billion worth of single-family mortgages. Two of the sales methods--security auctions and whole loan auctions--were used to sell most of the single-family mortgages--about $7 billion. (See p. 34.) The Association has had difficulties selling its multifamily mortgages and has tried four different sales methods between July 1, 1972, and March 31, 1976, under which it sold $1.1 billion of such mortgages. Most mortgages--$676 million--were sold by the whole loan method. (See p. 38.) iii ATTRACTION OF NONTRADITIONAL INVESTORS One of the Government National Mortgage Association's missions is to attract new investors into the mort- gage market, thereby increasing the amount of invest- ment capital available for mortgage origination. This is accomplished primarily through the sale of securities backed by Association-held mortgages and by guaranteeing securities--backed by pools of mortgages--issued by mortgage ortginators. As of March 31, 1976, outstanding mortgage-backed securi- ties guaranteed by the Association had a value of $23.3 billion; 35 percent of these securities had been iLurchased by the category of investors that normally did not invest capital in the mortgage market. Mortgages sold individually are purchased almost exclusively by traditional investors in the mortgage market, such as mortgage bankers and savings and loan institutions. (See p. 45.) MORTGAGE SALES ALTERNATIVES GAO's review of the Association's sales activity identified a number of alternatives that it believes warrant study by the Association because they have potential to increase revenues or otherwise improve operations. In a report to the Secretary of Housing and Urban Development (CED-77-16, November 29, 1976), GAO recommended that the desirability of implementing these alternatives be determined. The Government National Mortgage Association's ability to hold mortgages during periods when interest rates are relatively high is restricted by the Office of Management and Budget's required end of the fiscal year outlay ceiling. The sale of Association mortgages directly to the Federal Financing Bank would allow the Association to adhere to the Office of Management and Budget's imposed outlay ceiling, while it would eliminate the need to sell the mortgage in the private market under unfavorable conditions, thereby providing a potential opportunity to minimize losses. Negative features of such sales, such as worsening market conditions, must also be considered. (See p. 50.) When the Association holds a security auction, it offers a block of securities for sale requiring that the potential investor submit a bid for the iv entire block. As of March 31, 1976, only two large syndicates have submitted bids and purchased securities. The syndicates then resell the securi- ties at a profit. The Association might be able to receive a better return on the sale of securities if it sold the securities directly to investors. (See p. 54.) The Association requires that a security issue have a minimum value of $1 million. Its officials indi- cated they could have sold as securities some of the $501.3 million worth of mortgages the Association sold through whole loan auctions since January 1975 if the minimum had been $100,000. The Government National Mortgage Association should consider reducing the amount required for a ecurity issue to an amount less than $1 million because (1) its securities have been sold for a better price than the individual mortgages, and (2) securities' sales have attracted more nontraditional investors than have mortgage sales. (See p. 53.) v C o n t e n t s DIGEST CHAPTER 1 INTRODUCTION Secondary mortgage market 1 Government participation 1 Scope of review 3 7 SECONDARY MARKET OPERATIONS OF THE COVERNMENT NATIONAL MORTGAGE ASSOCIATION 8 Mortgage commitments and urchases 8 Disposition of commitments other than purchase via methods Guarantees o: mortgage-backed 17 securities 21 Comparison of commitments to housing starts and interest rates 2 3 SALE OF MORTGAGES AND MORTGAGE-BACKED SECURITIES 28 Factors influencing the sale of mortgages and securities Disposition of mortgages 29 Determination of sales 34 price 41 Yields on GNMA's and other Attraction of nontraditionalinstruments 42 investors 45 Management and liquidation of acquired mortgages Trustee operations 48 48 4 ALTERNATIVES TO PRESENT MORTGAGE SALES PRACTICES 50 An alternative to private market sales 50 Opportunity to obtain more in sales activities competition 53 Potential savings through of securities to private the direct sale investors 54 ABBREVIATIONS FHA Federal Housing Administration FHLMC Federal Home Loan Mortgage Corporation FNMA Federal National Mortgage Association GAO General Accounting Office GNMA Government National Mortgage Association HUD Department of Housing and Urban Development OMB Office of Management and Budget VA Veterans Administration RFC Reconstruction Finance Corporation CHAPTER 1 INTRODUCTION The Housing and Urban Affairs Subcommittee, Senate Committee on Banking, Housing and Urban Affairs, requested on October 22, 1975, that we review the Government National Mortgage Association's (GNMA's) operations in the secondary mortgage market. This review was to provide the Subcommittee information on the following matters during the period July 1, 1972, through March 31, 1976: -- The role played by GNMA in th\, secondary mortgage market. -- The nature and level of GNMA activities during the specified period. --The manner in which GNMA activities are conducted. -- The criteria used by GNMA in its decisions to sell mortgages and in determining sales price. On September 20, 1976, we presented testimony on GNMA's secondary mortgage market activities before the Senate Com- mittee on Banking, Housing and Urban Affairs. On October 5, 1976, arrangements were made with the Subcommittee to finalize the request by issuing (1) a report to the Secretary pointing out the need for certain improve- ments in GNMA's mortgage activities and (2) a staff study presenting additional information on GNMA's mortgage-buying and -selling activities. (See p. 50.) GNMA was created by the Housing and Urban Development Act of 1968 (12 U.S.C. 1717) as a Government-owned corporation within the Department of Housing and Urban Development (HUD). All GNMA's powers and duties are vested in the Secretary of HUD. The Secretary directs the administration of GNMA and, within limitations of the law, determines the general policies which govern GNMA's operations. SECONDARY MORTGAGE MARKET The majority of home mortgages are made by deposit institutions, such as savings and loan associations, mutual savings banks, and commercial banks, which obtain funds from depositors and invest these funds in mortgages as an earning asset. These institutions operate in the primary market where 1 investors normally allot a portion of their available anticipated funds for or mortgages. permanent investment in residential These primary lenders an independent group of and investors are supplemented mortgage lenders who originate mort- by gages primarily for sale of lenders, known as mortgageto others. This independent because of the following bankers, came into being group factors: -- There are significant differences in the supply mortgage money relative of to demand in various parts of the country and there a State or major metropolitan are also differences within area. -- It is not always economical for primary investors have their offices where to there is mortgage demand. The mortgage banker brings investor together by originating the borrower and primary in anticipation of finding mortgages for his own account Because mortgage bankers a ready market for such loans. usually do not have enough do not accept deposits of ments and, therefore, capital to make permanentfunds, they seek to sell the mortgages invest- originated. Some primary they have because they are located lenders are also sellers of mortgages generate enough savings in mortgage markets which do not to satisfy local mortgage demand. The secondary mortgage sale and purchase transactions market, therefore, consists originate mrtgages for between organizations thatof their all or some of the mortgages own account but expect to sell tutions (i.e., thrift they originate, institutions, insurance and other insti- State pension funds) interested companies, investments. in purchasing mortgages and as Although the secondary highly organized with mortgage market a centralized trading had not been two significant developments facility, recently operations. The first were implemented to improve gage Market Information was the creation of the Automated its Network, Inc., in June Mort- mortgage trade associations 1974 by five Corporation (PHLMC) (see and the Federal Home page 5 for a discussion Loan Mortgage The Network is a computerized of FHLMC). data bank which allows subscribers--240 as of its October 1976--to list instantly, computer terminals, mortgage information, via buy and sell, delivery times, loan-to-valuesuch as offers to ratios, prices on short-term money bonds, international market instruments, selected money rates, and the daily notes and trdding summary. The Network's securities objective is to increase 2 the liquidity of mortgage investments buy and sell them. Actual transactionsby making it easier to are not handled through the system but are handled privately person-to-eerson contact. by telephone or The second development was establishment of an interest rate futures trading market in GNMA mortgage-backed cates )y the Chicago Board of Trade in certifi- development of this market stems from October 1975. The interest rates which recently have beenthe volatility in the creating new risks and expenses for the morteage originator and investor. Thus, the purpose of this market, like commodity allow the risk to be shifted from mortgage exchanges, is to to speculators. The originator/investor originator/investor insulate his profit margin against loss is then able to speculator with the possibility of a while providing the profit. Trading units, called contracts, certificates with a principal balance are GNMA mortgage-backed of $100,000 and a stated interest rate of 8 percent. Around 114,000 tracts were traded during the first year GNMA futures con- of operation. Activ- ity in the futures trading market for GNMA futures contracts is regulated by the Commodity Futures Trading Commission. A bas.c dilemma of the mortgace market fact that as interest rates rise, deposits stems from the tutions decline and funds available for with thrift insti- mortgagse lending also decline. Consequently, mortgage who rely on the secondary market barkers and other originators for the permanent placement of their mortgage loans find their traditional unavailable. Under these circumstances, sources the mortgage bankers have used their available capital to they are unable to sell and thus they originate mortgages which originating new mortgages. lack the capital for GOVERNMENT PARTICIPATION The Government's initial participation mortgage market was in 1935, when in the secondary the Reconstruction Finance Corporation (RFC) was authorized to purchase Housing Administration (FHA)-insured certain Federal mortgages covering residential housing. These purchases were authorized to supplement the inadequate level of mortgage funding available in the secondary market. In 1938, in part because RFC pur- chases were insufficient to meet demands industry, the Federal National Mortgage of the housing Association (FNMA) was created to purchase FHA-insured mortgages. FNMA's authority was expanded to allow In 1948 it also to purchase Veterans Administration (VA)-quaranteed mortgages. The following section discusses the Government's participation 3 in th secondary market relating to the GoveLnment National Mortgage Association creation of the (GNMA). Government participation prior to creation of GNMA The Housing Act of 1954 (12 U.S.C. 1716, et seq.), entitled "Federal National Mortgage Association amended Title III of the National Housing Charter Act," Federal Government's participation in Act and recast the the secondary market. This was occasioned by the following: -- New types of Government-backed mortgages, renewal, low-cost and cooperative housing, such as urban assistance to encourage loan origination. required --A danger existed that market forces would result in increased offerings to FNMA of overpriced, less saleable residential and specific purpose mortgages where FNMA's original secondary mortgage to a point be adversely affected. function woul. -- Several organizations concerned with homebuilding and mortgage lending, such as the National Association of Home Bui ders and the United States Savings League, had advocated the formation of and Loan a secondary market facility which would ultimately become privately financed and operated. In recognition of the above, the FNMA Charter FNMA to establish separate accountability Act required for the following three functions: --The original support program for FHA-insured VA-guaranteed mortgage financing, including and housing loans insured by the Farmers Home some rural tior, and FHA-insured home improvement Administra- loans. Under this function FNMA was authorized to provide mentary assistance to the secondary market supple- for home mortgages by providing a degree of liquidity mortgage investments. By purchasing mortgages for originators, such as mortgage bankers, from provide, as needed, a market where the FNMA would could sell their mortgages and obtain originators funds with which to originate new mortgages. -- Special assistance was to be provided through FNMA's purchase of urban renewal, low-cost and housing and other new types of Governmentcooperative instruments that were not attractive to financing private 4 investors because of their below-market interest rates. Such assistance was to be provided when either the President of the United States should deem it in the public interest or the Congress should specifically designate special programs. Eligible mortgagee had to meet, in general, the purchase standards of private mortgage investors, but specifically were not required to be readily acceptable to private investors. -- The management and liquidation of federally owned mortgages in the existing portfolio. FNMA's responsi- bilities consisted of managing and liquidating these mortgages with a minimum adverse effect on the home mortgage market and a minimum loss to the Government. Government participation after the creation of GNMA The Housing and Urban Development Act of 19Fq (12 U.S.C. 1717) was occasioned by the reformation of the Fr'eral budget to a unified basis. Under the unified budget concept, FNMA's expenditures would have been carried as budget outlays even though the purchasing funds were obtained principally through borrowings from the public. It was feared that representation of FNMA's expenditures as budget outlays would have an adverse effect on FNMA's response to home financing demands, so the Congress enacted legislation to partition FNMA into two con- tinuing entities. One entity, the new FNMA, was created to carry out secondary market operations financed entirely by private sources. The other entity, GNMA, war established within the Department of Housing and Urban Development to carry out, as needed, certain of the activities carried out by the old FNMA. In July 1970, to strengthen and further develop the secondary mortgage market, primarily in conventional mortgages, the Federal Home Loan Mortgage Corporation was created under Title III of the Emergency Home Finance Act of 1970 (12 U.S.C. 1452 et seq.). FHLMC, which is wholly owned by the Federal Home Loan Bank System, was created to buy and sell conven- ional, FHA-insured and VA-guaranteed mortgages. The same act also amended the Housing and Urban Development Act of 1968 to authorize FNMA to purchase and sell conventional mortgages. Before 1970 there was no secondary market facility for conventional residential mortgages. FNMA and FHLMC perform similar functions. The primary differences between FNMA and FHLMC are as follows: -- FHLMC was created primarily to purchase conventional mortgages for which there was no secondary market 5 facility. FNMA, on the other hand, was established to purchase FHA-insured and VA-guaranteed mortgages and until July 24, 1970, was not authorized to purchase conventional mortgages. -- FHLMC purchases mortgages primarily from savings and loan organizations, whereas FNMA purchases mortgages primarily from mortgage banker organizations. Under the 1968 act, GNMA was directed to carry out the following activities that were previously carried out by the old FNMA: -- Perform secondary mortgage market activities funded through Government borrowings. -- Purchase home mortgages as directed by either the President or the Congress. -- Manage and liquidate a portfolio of mortgages formerly held by FNMA. -- Act as trustee for a number of trusts for which FNMA had been the trustee. The act also authorized GNMA to guarantee securities, backed by pools of mortgages, issued by either the new FNMA or by other GNMA-approved mortgage originators. GNMA's authority to sell mortgages was changed significantly in 1969, when it was authorized to sell mortgages at a discount (less than the unpaid principal balance). Before 1974 GNMA as authorized to purchase and sell mortgages that were Government insured or guaranteed. GNMA's authority was broadened by the Emergency Home Purchase Assist- ance Act of 1974, which authorized GNMA to participate in the single family conventional mortgage market. Subsequently, GNMA was authorized by the Emergency Housing Act of 1975 to purchase and sell conventional multifamily mortgages. Servicing agreements GNMA fulfills its legal responsibility by making the major decisions on policy matters, such as the timing, amount, and methods of mortgage purchase and sales. However, the day-to-day operations of GNMA's programs are carried out by FNMA and a portion of one program is carried out by FHLMC. 6 GNMA is bound to the new FNMA and FHLMC by servicing agreements which provide that these organizations perform certain services to administer and operate GNMA's programs. The combined services agreement between FNMA and NMA provides that FNMA administer and operate all GNMA Special Assistance Programs, the GNMA/FNMA Conventional Home Mort- gage Program, and perform certain services in connection with the GNMA mortgage-backed security program, as such programs exist and are operated as of June 1, 1975. The mortgage purchase and servicing agreement between FHLMC and NMA pro- vides that FHLMC perform certain services to administer the GNMA/FHLMC conventional home mortgage program. The agreements among GNMA and FNMA and FHL'C stipulate that FNMA and FHLMC shall provide the necessary personnel, equipment, and facili- ties to perform their respective services. Services to be performed under both agreements include approval of sellers, administration o commitments, loan review, purchasing mortgages, supervision of servicing, recordkeeping, mortgage liquidation, and roperty disposi- tion. Additional services provided under the FNMA/GNMA agreement include servicing FHA project mortgages in GNMA's portfolio, spot checking purchased conventional home mort- gages, selling mortgages, and reviewing mortgage-backed securities. GNMA incurred servicing expenses of $22.5 million-- $21.1 million to FNMA and $1.4 million to FHLMC--under both agreements during the 3-1/2 year period from July 1, 1972, to December 31, 1975. SCOPE OF REVIEW We conducted our review at GNMA headquarters in Washington, D.C.; interviewed GNMA officials; obtained de- scriptions of GNMA's activities; identified prices paid and received for mortgages in GNMA's purchasing and selling opera- tions; and evaluated GNMA's criteria regarding the purchase and sale of mortgages. We examined pertinent legislation, administrative regulations, and records of operation. We also interviewed officials of FNMA and FHLMC concerning their selling practices, officials of organizations that participate in the secondary market for mortgages, and knowledgeable individuals in the field of housing finance. In addition, we obtained statistical data on economic factors, such as housing starts and mortgage interest rates, which affect GNMA's operations. 7 CHAPTER 2 SECCNDARY MARKET OPERATIONS OF THE GOVERNMENT NATIONAL MORTGAGE ASSOCIATION The Housing and Urban Development Act of 1968 (Act) directs GNMA to participate in the secondary mortgage market to: -- Make mortgage financing available for segments of the population which are unable to obtain adequate housing under established financial programs. -- Retard or stop declines in homebuilding and mortgage lending. -- Encourage originators to expand their allocations for mortgage investments. -- Attract nontraditional sources of long-term investment capital to the mortgage market. GNMA attempts to accomplish these missions primarily by: -- Issuing to mortgage originators commitments to purchase mortgages with primarily below-market interest rates. -- Purchasing and selling such mortgages. -- Guaranteeing securities, backed by pools of mortgages, that are issued by approved mortgage originators. In addition the Act directs GNMA to manage and liquidate federally owned mortgages, acquired from FNMA and other Govern- ment agencies, with minimal adverse effect on the home mortgage market. MORTGAGE COMMITMENTS AND PURCHASES A commitment contract is an agreement by GNMA to purchase, at a pre-established price, mortgages that are made by a mort- gage orginator. The commitment stipulates the type of mortgage, dollar amount, mortgage interest rate (generally below-market interest rate), and date by which the commitment must be exercised. For instance, GNMA might make a commitment with a mortgage originator to purchase $5 millioni worth of conven- tional mortgages with interest rates of 8 percent within 1 year from the commitment date. 8 Commitments are directed at stimulating homebuying home construction by assuring originators that the and mortgages they originate may be sold to GNMA if the- do not hold them. This assurance is intended to (1) want to encourage originators to make commitments to builders and to make it easier for the builder to obtain construction financing and (2) sell homes because it assures the builder that poten- tial homebuyers will be able to obtain mortgage financing. Commitments are also intended to make homebuyers' mortgage payments lower than they would be otherwise the commitments stipulate the interest rate that the since must bear, which is generally below-market interest mortgages rates. Although the availability of below-market interest through GNMA's various programs are intended to stimulaterates homebuying and home construction, studies performed by and an economist on the President's Council of Economic HUD Advisors to ascertain if the programs are meeting their tives have resulted in different conclusions. Our objec- these studies and discussion with financial experts review of about GNMA's programs disclosed the following reasons for difficulty in measuring the impact of GNMA's program:the -- The program is relatively new, particulary the portion authorized in 1974 and 1975 under emergency legislation. --Econometric models, which financial experts use as primary method to measure programs of this type, area not sufficiently developed to measure GNMA's program. Presently GNMA is authorized to make commitments for FHA, VA, and conventional single and multifamily mortgages. Before September 1974, however, most commitments were for FHA-insured and VA-guaranteed mortgages on single family multifamily dwellings. On October 18, 1974, GNMA was and authority to make commitments for conventional single given family mortgages and on July 2, 1975, for conventional multifamily mortgages. Commitments to purchase single family mortgages provide a 1-year period during which the mortgages must be made and delivered to GNMA for purchase. A single exention of 3 can be granted. Multifamily commitments provide periods months 2 years for delivery with the possibility of more than of one extension of 30 days each. If and when an originator delivers mortgages for purchase to GNMA against an outstanding commitment, GNMA pays the 9 originator the price agreed to in the commitment contract and becomes the holder of the mortgages. By selling the mortgages to GNMA, the originator obtains capital which may enable him to make additional mortgages while at the same time continue to service the mortgage for a fee equal to three-eighths of one percent a year of the unpaid principal. In addition to purchasing mortgages against commitments, GNMA, before fiscal year 1975, purchased mortgages directly from originators through immediate purchase contracts. How- ever, since then GNMA's mortgage purchases have been limited to purchases against outstanding commitments. In a few cases FNMA has been permitted to purchase mortgages against GNMA commitments. Authority for GNMA commitments and purchases GNMA's mortgage commitment and purchase activities, referred to as its special assistance functions, are carried out under two separate authorities--traditional special assistance and emergency special assistance. Traditional special assistance The Housing and Urban Development Act of 1968 (1968 Act) transferred traditional special assistance authority to GNMA from the predecessor, FNMA. Under this traditional special assistance function, GNMA is authorized to make commitments to purchase and to purchase mortgages of certain types either selected by the President or identified by the legislation. Section 305(c) of the 1968 Act authorized $5.6 billion as of March 31, 1976, to make commitments and purchases of specific types of mortgages selected by the President. Under this authority, GNMA can make commitments to purchase and can purchase all types of mortgages, except conventional, when and as directed by the President. Sections 305(e), (f), and (g) of the 1968 Act provide a total of $2.2 billion to make commitments to purchase and to purchase specific types of mortgages identified within those sections. A breakdown of the $2.2 billion by section of the 1963 Act follows. -- Section 305(e)--$225 million for cooperative housing. -- Section 305(f)--$224 million for armed services and low- and moderate-income housing. -- Section 305(g)--$1.75 billion for new low-cost housing. 10 The amount of GNMA mortgage commitments and purchases under each authority is limited by the legislative ceilings on the total combined amount of commitments outstanding and mortgages held in GNMA's portfolio under each authority at any one time. When the total amount of GNMA commitments and mortgages reaches the ceiling level, GNMA is prohibited from making any new commitments under that authority. How- ever, as it disposes of commitments made or sells mortgages purchased pursuant to that authority, it can then make new commitments up to the amount of the commitments disposed of or mortgages sold. This action is referred to as "rolling over" mortgages and is also applicable to the emergency special assistance programs discussed below. The following chart presents the status of GNMA's commitments, purchases, and authorization balance, as of March 31, 1976, for each section of the Act. Total Net Section of authori- Purchases Commitments authorization the Act zation outstanding outstanding balance ------------------- (millions)----------- 305(c) $5,551.2 $3,385.4 $1,801.5 e 364.3 305(e) 225.0 112.5 112.5 305(f) 224.0 170.8 - 53.2 305(g) 1,750.0 408.4 202.1 1,139.5 Total $7,750.2 $4,077.1 $2,003.6 $1,669.5 GNMA's fiscal year 1977 budget request indicates it does not intend to issue commitments during that fiscal year under any of the above programs. Emergency special assistance Emergency special assistance was authorized by the Emergency Home Purchase Assistance Act of 1974 (12 U.S.C. 1723), approved October 18, 1974, and the Emergency Housing Act of 1975 (12 U.S.C. 2701), approved July 2, 1975. These acts authorized $7.75 billion and $10 billion, respectively, in new mortgage commitment and purchase authority over and above GNMA's traditional special assistance authority. This authority was granted for a limited, specified period. The 1974 Emergency Act (1974 Act) amended the Housing and Urban Development Act of 1968 by providing that the authority could be utilized whenever the Secretary of HUD finds infla- tionary conditions are having a severely disproportionate 11 effect on the housing indus;try, and that a resulting reduction in the volume of home construction or acquisition threatens co affect the economy and to delay the orderly achievement of national housing goals. The 1974 Act broadened GNMA's authority by authorizing the commitment and purchase of conventional single family mortgages as well as FHA and VA mortgages. The 1974 Act stipulated that the total amount of outstanding commitments and purchases under this new authority should not exceed $7.75 billion outstanding at any one time. The total commitment authorization was fully released by June 24, 1975, and fully committed by August 11, 1975. The 1975 Emergency Act extended GNMA's purchase authority under the 1974 Act to July 1, 1976, and authorized an addi- tional $10 billion, but provided that funds authorized under the 1975 Emergency Act were subject to release in an appro- priation act. GNMA's authority was broadened further to include conventional mortgages on multifamily structures and condominium units. The 1976 Appropriation Act only released mortgage purchase authority of $5 billion, which was available for commitment through July 1, 1976. Only $3 billion of the $5 billion authority provided by the 1976 Appropriation Act was actually made available to GNMA for commitments in fiscal year 1976. Mortgage commitment and purchase programs GNMA classifies specific commitments and purchases of mortgages by various programs. As of December 31, 1975, GNMA had a total of 16 programs under which it had issued commit- ments or purchased mortgages since July 1, 1972. The following are examples of 2 of the 16 programs. Program Number 19--FHA and VA single and multifamily mortgages for prefabricated housing and ousing which repre- sents the development of new and better construction methods. Program Number 20--Purchase of FHA and VA single and multifamily mortgages on properties in Guam. Each program represents a specific authorization to make commitments and purchases of certain types of mortgages usually at a stipulated interest rate. Timing and amount of commitments The decision to make commitments to purchase and the total amount to be committed is determined by a combination of actions by the Congress, the President, the Office of 12 Management and Budget (OMB), and the Secretary of HUD. input in the decisionmaking GNMA's process consists of suggestions to the Secretary concerning the status of the housing and the need for governmental market type and amount of mortgages intervention, including.the to be purchased. The actual timing and amount of funding authority apportioned to GNMA is determined by OMB based on requests made by HUD and the President. HUD's requests are based combination of economic indicators, on a including national housing starts, interest rates, feedback their willingness to participate from builders and lenders on in a GNMA program, and analyses indicating the effects of various funding levels GNMA's outlay ceiling. on The amount initially requested and apportioned by OMB may be substantially less than from congressional authorization. the orized $5 billion of emergency For example, the Congress auth- special assistance authority for conventional, FHA, and VA housing under the 1976 priation Act, pursuant to Appro- the Secretary of HUD's finding inflationary conditions are that having a severely disproportionate effect on the housing industry, as discussed on page 11 of this report. However, HUD made only $3 commitment during fiscal year billion available for 1976. Determination of mortgage interest rates GNMA determines the interest it makes commitmernts or purchases rates of mortgages for which under traditional special assistance based on recommendations the VA for VA-guaranteed from the Administrator of mortgages and from the Secretary HUD for FHA-insured mortgages. of rates vary among traditional The specified mortgage interest programs. For instance: -- Four of GNMA's programs specify that the mortgages have interest rates equivalent to the maximum FHA rate prevailing at the date of commitment. -- Another program permits between 7 percent to the interest rates to vary from maximum allowed FHA rate. -- Two other programs specify a rate of 8 percent. The interest rates of mortgages for which GNMA makes commitments and purchases under emergency special assistance are specified in the legislation. The law now limits the rate specified in commitments to the lesser of 7.5 percent or the rate set by the Secretary of HUD for mortgages insured under Section 203(b) of the National Housing Act. 13 Determination of purchase price The commitment to purchase mortgages specifies the price that GNMA agrees to pay the originator when GNMA purchases mortgages against the commitment issued under both the tra- ditional and emergency programs. For example, the commitment states that GNMA will purchase the mortgages at 98. This means that GNMA will pay the originator 98 percent of the loan's unpaid balance at the time it is delivered for pur- chase. In ffect then, GNMA is purchasing the mortgages at a 2-percent discount. GNMA has made commitments at purchase prices rangin from 96 to 100 under its current programs. According to GNMA officials, the purchase prices are determined subjectively. In establishing the purchase price the primary consideration is given to providing for a discount that will cover GNMA's costs to the extent feasible under prevailing market conditions. However, according to GNMA officials, when commitments are being made concurrently under several programs with different interest rates, the above consideration may be waived in favor of setting a purchase price that will maintain a comparable effective interest rate (combination of purchase price and mortgage interest rate) among different programs. This is done to maintain a competitive balance among GNMA's programs so that commitments under one program do not become more attractive than commit- ments under its other programs. GNMA usually purchases mortgages at a discount. However, in a few instances, because of a desire to stimulate the origination of a certain type of mortgage, GNMA has made com- mitments with a purchase price of 100, which means that no discount is involved. In these instances, GNMA agrees to purchase the mortgage at a price equivalent to 100 percent of the loan's unpaid balance at the time it is delivered for purchase. Fees charged on commitments and purchases In issuing commitments and purchasing mortgages, GNMA generally imposes certain fees on the originator in addition to the discount. These fees are: -- A commitment fee, varying from one-hclf of 1 percent to 2 percent of the commitment amount depending on the program, imposed at issuance of the commitment. -- A processing fee of one-one undredth of 1 percent of the commitment imposed at issuance of the commitment. 14 -- A purchase and marketing fee or a loss reserve and marketing fee varying from one-half of 1 percent to 1.5 percent of the unpaid principal balance depending on the program, which is deducted from the amount GNMA pays for the mortgage. GNMA's Sellers Guide permits the originator to pass these fees on to the builder and homebuyer. Effect of discount and fees on builders and homebuyers GNMA's commitment generally requires the mortgage originator, if he elects to exercise the commitment, the mortgage to GNMA at a discount. to sell In order to compensate for this discount, the originator will generally premium from the builder and homebuyer when receive a originating the mortgage. For instance, if the purchase price under a ment is 96, the originator is discounting the commit- purchase price of the mortgage to GNMA by 4 percent. In order to recover this discount, the originator in making the mortgage charge the borrower 4 points (1 point is equivalent will 1 percent) as a premium for making the loan. to 4 points on a $30,000 mortgage is $1,200. A premium of In this case, the builder and the borrower, usually in combination, pay the originator the premium of $1,200 when the mortgage is originated. Because GNMA limits the points that can be by the homebuyer to 1.5 percent of the mortgage paid amount, the bulk of the premium ($750 in the example) is paid by the builder. Illustrative chronology of a commitment Presented below is a description and chronology actions that occur from the time GNMA is directed of to issue commitments to the time GNMA purchases the mortgages. To simplify the illustration we narrow the scope from the total amount available for commitment to GNMA's purchase of a single mortgage. In the fall of 1974 the Secretary of HUD decided GNMA should supplement the construction of that homes by making commitments and purchases of conventional, FHA-insured and VA-guaranteed single family mortgages. Pursuant to authority assigned by the Emergency Home Purchase Assistance 1974, the Secretary requested OMB to release Act of authority of $3 billion to GNMA. OMB released authority to GNMA in October 1974. 15 GNMA announced the offering of $3 billion worth of commitments to purchase conventional single family mortgages. In accordance with the Emergency Home Purchase Assistance Act of 1974, GNMA limited the maximum mortgage amount to $42,000, except for properties in Alaska, Hawaii, and Guam, which had higher mortgage limits, and required mortgages to bear interest at 8 percent. The commitments guaranteed GNMA would purchase eligible mortgages at 98 percent of their unpaid principal amount at the time of delivery. A builder of single family homes saw the announcement and contacted a savings and loan (originator) requesting a GNMA commitment to purchase $5 million worth of mortgages. The savings and loan contacted GNMA and requested a GNMA com- mitment to purchase $5 million worth of conventional single family mortgages. Upon GNMA's approval of the commitment request, a notice signifying a commitment contract was sent o the savings and loan. The notice stated -- the amount of the commitment, $5 million; -- the interest rate the mortgages must bear, 8 percent; -- the expiration date of the commitment, 12 months after approval date; and -- other pertinent information, such as fees due. Upon receipt of the notice the savings and loan paid GNMA a commitment fee of 1 percent, $50,000 (1 percent of $5 million), and a processing fee of one-one hundredth of 1 percent, $500 (one-one hundredth of 1 percent of $5 million), for a total of $50,500. The savings and loan issued commitments to the builder for the amount it requested. The commitment allowed the builder to advertise the availability of financing at 8 percent interest rates. A buyer agreed to purchase a home and obtained an 8 percent mortgage for $42,000 from the originator. GNMA ex- pects originators to charge builders and buyers only such fees as are necessary to cover the costs of originating the mortgages and participating in GNMA's program (GNMA program fees and discounts). The originator would carge 3-1/2 points, 1 to be paid by the buyer and 2-1/2 by the builder 16 to cover the following: origination fee (1 percent); GNMA discount (2 percent); and GNMA purchase and marketing fee (one-half of 1 percent). After settlement of the mortgage, the savings and loan delivered the $42,000 mortgage and additional documentation, such as the certificate of mortgage insurance, to a FNMA regional office. Upon approval of the mortgage's documenta- tion by the regional office, GNMA paid the savings and loan $40,950 (97.5 percent of the $42,000), deducting a 2 percent discount plus one-half of 1 percent purchase and marketing fee. In addition, GNMA allowed the savings and loan to keep the servicing contract on the mortgage from which the originator annually receives three-eighths of 1 percent of the unpaid principal. DISPOSITION OF COMMITMENTS VIA METHODS OTHER THAN PURCHASE All commitment contracts GNMA issues do not result in mortgage purchases. From July 1, 1972, through March 31, 1976, commitments totaling about $6.6 billion have been satisfied by other than the purchase of mortgages in the following ways: -- The originator canceled his commitment contract or allowed it to expire. -- The originator or other private investor assumed the commitment contract. These actions release GNMA from its obligation to purchase mortgages and have the advantage of not increasing FNMA's borrowing from Treasury. This in turn reduces the amount of mortgages GNMA must sell to remain within the OMB outlay ceiling, discussed on page 33. Further, since rolling over of mortgages is permitted, eliminating commitments enables GNMA to make additional commitments up to the same amount as those commitments it eliminated. Cancellation GNMA's single family and multifamily commitments to purchase mortgages expire after 12 months and 24 months, respectively. Extensions to these time periods can be obtained before the commitment expiration date. According to GNMA offi- cials, commitments are not used primarily because the origina- tors are not able to make enough mortgages to utilize their 17 full commitment amount because the builders are not able to complete construction. In fiscal year 1975 under a one-time arrangement, commitments worth $395.6 million were canceled. By canceling its commitment contract before expiration, the originator received a refund of one-half of the commitment fee paid to GNMA. If the commitment was not canceled, GNMA would have retained the entire commitment fee. Assum tion of commitment by originator or private investor The assumption of a GNMA commitment by the mortgage originator holding the commitment releases GNMA from its obligation to purchase mortgages made under the commitment. Under an assumption, also referred to as "buy-back", the originator agrees to assume the commitment and to retain the mortgages at the commitment price provided that GNMA pays at the time the mortgage is fully disbursed a price differential equal to the excess of the commitment price over the market price. According to testimony by a GNMA official at hearings in September 1975 oefore the Subcommittee on Housing and Urban Affairs of the Senate Committee on Banking, Housing and Urban Affairs, the price differential payable on each mortgage re- sults in the same effect on GNMA as if the mortgage had been purchased by GNMA and sold in the marketplace. For example, GNMA issued a commitment to purchase a conventional mortgage, bearing an interest rate of 7.5 percent, from an originator at 96 and the published GNMA repurchase price was 92. The originator may (1) assume or "buy-back" the commitment con- tract, keep the mortgage, and receive the 4 percent (96-92) differential from GNMA or (2) sell the mortgage to GNMA at the agreed upon price of 96 and then GNMA could resell it at 92. To effect an assumption, the mcrtgage is not submitted for purchase pursuant to the commitment contract, but instead presented for validation. A GNMA official told us that the advantages of the assumption or buy-back of the commitment to GNMA as compared to the purchase and subsequent resale of mortgages by GNMA under the commitment were: -- Saving administrative expenses, such as transferring title to the mortgage to GNMA and carrying the mort- gage in inventory. -- Eliminate selling expenses associated with disposing of mortgages at auctions. -- Reduce the amount of GNMA borrowing from the Treasury. 18 Another potential advantage, according to a GNMA official, is that if mortgage market conditions deteriorate (see page 33) GNMA's loss on the sale of mortgages could exceed the amount of the price differential that it would have paid if the mortgage had been assumed. The use of assumptions was initiated in 1969, under the "tandem plan" agreement between GNMA and FNMA. Before August 1971, assumption transactions were exclusively between GNMA and FNMA. Since August 1971, GNMA has entered into assumption transactions with the commitment holders and other investors in addition to FNMA. From July 1, 1972, through March 31, 1976v FNMA assumed $42.8 million of GNMA commitments. Initially, the term "tandem plan" referred specifically to assumptions by FNMA. However, since August 1971 the term has been used to refer to any transaction by which originators, because they pay a price differential, retain their mortgages rather than deliver them for purchase by GNMA under commitment contracts. The terms also refers to programs for the sale of mortgages from GNMA's portfolio to other investors, such as savings and loans and mortgage bankers. From July 1, 1972, to March 31, 1976, commitments to purchase FHA and VA mortgages in the amount of $5.4 billion have been satisfied by assumptions. The assumption of commitments, 1/ also referred to as buy-back, for conventional mortgages was initiated in October 197.. GNMA experienced difficulties in selling conventional mortgages. In September 1975, GNMA decided to sell single family conventional mortgages worth $350 million through an auction; however, by contacting savirgs and loans, mortgage bankers, and other market representatives, GNMA found there was not demand for such mortgages and, therefore, canceled the auction. A GNMA official told us that, in his opinion, the main problem with selling conventional mortgages is that GNMA does not guarantee the payment of principal and interest on these mortgages to investors, and the cost and time involved for investors to review each mortgage to determine if it is a 1/ The GNMA/FNMA Conventional Home Mortgage Guide refers to the assumption of commitments for conventional mortgages as repurchase option, but to facilitate our discussion we use the term assumption of commitment. 19 good risk is prohibitive. According to a GNMA official, OMB believes the Government should not furnish a guarantee because of the contingent liability associated with a Government guarantee. To eliminate the problem of investors lacking sufficient knowledge of the mortgages, GNMA decided to allow the originators to buy-back their commitments. GNMA had disposed of 23,081 conventional commitment contracts worth $783.1 million by this method as of March 31, 15;6. Statistics on GNMA commitments, purchases and other methods of disposition The following table summarizes GNMA's commitment and purchase activity from July 1, 1972, through March 31, 1976. Committing and Purchasing Activity By Dollar Amount FY 1973 FY 1974 FY 1975 FY 1976 Total ------ …------------- (millions)------------------- Commitments Traditional authority $4,785.6 $3.028.4 $5,844.6 $ 361.5 $14,020.1 Emergency authority Conventional - 4,935.6 2,000.0 6,935.6 Other - - 98.6 280.2 1,278.8 Total - - 4.2 2,2e7 T21T Total commitments $4,785.6 $3,028.4 $11,778.8 $2,641.7 $22,234.5 Purchases Traditional authority $1,414.7 $1,542.2 $3,056.2 $2,320.9 $8,334.0 Emergency authority Conventional - 422.1 2,557.0 2,979.1 Other - 185.3 605.4 790.7 Total - - 607.4 3,162.4 3,769.8 Total purchases $1,414.7 $1,542.2 $3,663.6 $5,483.3 $12,103.8 Other transactions Cancellations and expirations $ - $ - S 395.6 S - $ 395.6 Assumptions 2,324.4 1,341.0 1,721.5 783.1 6,170.0 Total $2,324.4 $1,341.0 52,117.1 $783.1 $6,565.6 20 GUARANTEES OF MORTGAGE- BACKED SECURITIES The National Housing Act (12 U.S.C. 1721) authorizes GNMA to guarantee mortgage-backed securities issued to the public by the new FNMA or by any other GNMA-approved issuer. The full faith and credit of the United States is pledged to the payment of all amounts which may be required to be paid under any such guarantees. The purpose and effect of the GNMA guarantee is to encourage established mortgage origina- tors to expand their allocations for mortgage investment and to attract nonmortgage-oriented sources of lng-term investment capital into the field of housing finance. The results of the latter are discussed in Chapter 3. Application fees, guaranteec, and other charges are assessed issuers of guaranteed securities to cover costs incurred by GNMA in connection wiLl the guarantees and to help offset possible future payments of claims under the guarantee. Funds received from these fees and charges are used to finance GNMA expenditures and, when possible, to reduce GNMA's outstanding borrowings. When necessary, GNMA borrows from the Treasury to meet requirements of claims under the guarantee. The issuer is responsible for administering the mortgage pools backing the securities, including the collec- tion of the principal and interest on the mortgages. In the event that the issuer defaults in making timely payment of principal and/or interest to the owner of the garanteed security, NMA may make the payment and take title to the mortgages backing the security. Under regulations promulgated by the Secretary of HUD in May 1970 (24 F.R. 1665), the securities may be issued as a pass-through or a bond. On pass-through securities, principal and interest are paid monthly to the security owners. On bond securities, interest is paid semiannually and principal is paid at maturity. FNMA and FHLMC have been the only issuers of bond securities. GNMA had guarantees outstanding at March 31, 1976, of $23.3 billion, of which $19.5 billion was insured from the beginning of fiscal year 1973 through March 31, 1976. All securities to date have been backed by FHA-insured and VA-guaranteed mortgages; however, the Emergency Home Purchase Assistance Act of 1974 authorizes the guarantee of securities backed by conventional mortgages which are purchased or eligible for purchase by GNMA. GNMA's risk through guaranteeing securities backed by FHA or VA mortgages 21 is limited to the excess of interest expense, attorneys' fees, and other costs involved in foreclosure, and uninsured property damage, over and above amounts allowable by FHA or VA in t -etKtlement of mortgage insurance and guarantee claims. . risk increases when the securities are backed by conventional mortgages, since the guarantee of the securi- ties is tantamount to a guarantee of the mortgages themselves. As of March 31, 1976, GNMA had not guaranteed any conventional mortgages. COMPARISON OF COMMITMENTS TO HOUSING 3TARTS AND INTEREST RATES GNMA attempts to retard or stop declines in housing construction and mortgage lending, and to provide suitable financing for low- and middle-income segments of the popula- tion by issuing commitments to purchase home mortgages. The number of housing starts and mortgage interest rates are two of the most important indicators of the conditions of the housing industry according to officials at HUD. The Secretary of HUD continually receives information con- cerning housing tarts, mortgage interest rates, and other economic indicators from her advisors, including GNMA. This information is also available to the President and the Cungress for determining when GNMA should be directed to make commitments. GAO observed single and multifamily housing starts as an indicator of GNMA's responsiveness to declines in home construction. One of GNMA's goals is to issue commitments in reaction to declines in housing starts. The generally below-market interest rate mortgages originators made pursuant to the commitments are intended o stimulate demand for more housing. Also the commitments obtained by builders from the originators enables them to obtain construction financing. The following graphs show the relationship of the amount of GNMA's commitments for both single and multifaenily mortgages to the number of single and multifamily housing starts / each month from July 1972 through December 1975. 1/ Housing starts, representing new privately owned housing, seasonally adjusted were obtained from the U.S. Depart- ment of Commerce, Bureau of the Census, publication "Housing Starts." 22 zjP- -Z zO .. Z ,, ~/) a ! (0 0 'I - ~~~~~~~~C1(~~~~~~~~~~~~~~~~~~~~~~,, It o A 23 U z < v,~~~~~~~ v I- . oo - -------------- - . ----------- -- - J-J ' -- CD oIf~~~~_ - E z o I R~ ,- o o *o,,° oe o , 8xI z 24 GNMA believes that as mortgage interest rates increase, certain segments of the population are prohibited from purchasing homes because the increasing interest rate results in higher mortgage payments, which are too costly for some segments of the population. By encouraging ri- ginators to make mortgages at below-market interest rates through commitments to purchase those mortgages, GNMA intends to enable these marginal borrowers to purchase homes. In addition to observing the timeliness of GNMA's commitments in response to declines in housing starts, we compared the timing and amounts of GNMA commitments for single and multifamily mortgages issued with the interest rates for conventional mortgages, which financial experts consider to be a reasonable indicator of mortgage interest rates, from July 1, 1972, through December 31, 1975. The following graph presents the amounts of commitments GNMA issued in relation to the average monthly interest rates for conventional mortgages. Interest rates are the average percentage for the month indicated. 25 ac I / ' - Ic~~~~~~~~~-~~. O n, .. -- _ o e I--- -\. 1 z %v C, c- c U) _ W F , 0 0 4 - zI I I I-o o c o , , LU a * ~~z-j~2 0.02 w - I~~~~2 Based on the, information reviewed and presented in the graphs, it appears GNMA usually responded to declines in housing starts and increases in mortgage interest rates by increasing the amount of commitments issued, therefore making available below-market interest rate mortgages. This appears to be in concert with GNMA's missions of retarding or stopping declines in home construction and mortgage lending, and pro- viding financing for segments of the population which may be unable to purchase housing due to the relatively high interest rates. 27 CHAPTER 3 SALE OF MORTGAGES AND MORTGAGE-BACKED SECURITIES GNMA sells mortgages and mortgage-backed securities to obtain revenues to finance additional mortgage purchases and to attract additional investment capital to the mortgage market. The amount of mortgages and securities which GNMA sells and the price received for them are influenced primarily by OMB-established expenditure ceilings and the condition of the mortgage market at the time of sale. This chapter discusses the amount and source of GNMA's :evenues, factors influencing the sale of mortgages and securities, methods of disposition of single and multifamily mortgages, and the relative success of the various instru- ments sold by GNMA in attracting additional investment capital to the mortgage market. GNMA finances the purchase of mortgages and related operations through borrowings from the Treasury and revenues it receives primarily from the following: -- Proceeds from the sale of mrtgages and mortgage- backed securities. -- Payments of principal and interest received on the mortgages in its portfolio. -- Various fees and charges. GNMA's revenues are used to pay current expenditures, such as mortgage purchases or administrative expenses. Revenues in excess of those needed to ay current expenses are paid to the U.S. Treasury to reduce the level of GNMA's outstanding borrowings. The following table summarizes, by activity, GNMA's revenues used to make mortgage commitments and purchases during fiscal years 1972-75. 2: Fiscal year Percent 1973 1974 1975 Total of total ------ (millions)------ Receipts from: Mortgage loan repayments and other credits $ 293.6 $ 253.5 $ 313.2 $ 860.3 14.74 Interest on mortgage loans 164.5 149.0 225.2 538.7 9.23 Mortgage sales 1,583.0 1,502.8 1,296.2 4,382.0 75.07 Commitment fees 1.8 1.1 4.8 7.7 .13 Other revenues (see note a) 15.4 16.1 16.8 48.3 .83 Total receipts $2,058.3 $1,922.5 $1,856.2 $5,837.0 100.0 a/ Includes purchase and marketing fees, recovery of prior years expenses, etc. As can be seen in the previous table, more than 75 percent of GNMA's revenues during the period of fiscal years 1972-75 resulted from the sale of mortgages and mortgage-backed securities. Like all other revenues the pro- ceeds from the sale are used to pay expenses and to reduce the amount of GNMA's outstanding borrowings from the Treasury. The sale of the mortgages and securities also enables GNMA to substitute private for Government financing. FACTORS INFLUENCING THE SALE OF MORTGAGES AND SECURITIES Timing sales to market conditions GNMA generally purchases mortgages with interest rates below the prevailing market rate for a higher price than private investors would be willing to pay. Therefore, in the absence of a significant decrease in prevailing market interest rates, when GNMA offers mortgages and mortgage- backed securities for sale to private investors, they are generally purchased at a lower price than GNMA paid to acquire the mortgage, which results in a loss to GNMA. The degree of loss GNMA suffers can be reduced by timing sales to take advantage of favorable market conditions. GNMA mortgages and securities must compete for investors with 29 other financial instruments. As a result, the price GNMA receives from the sale of its mortgages and securities is greatly influenced by the effective rate of return (yield) of competing financial instruments. Prevailing market interest rates for mortgages reflect the yield that an investor would realize through the origina- tion of a mortgage. An investor interested in investing his money in mortgages has the option of originating a new mortgage or purchasing an existing mortgage in the secondary mortgage market. If the existing mortgage was made at an interest rate higher than the prevailing market rate, the purchaser will generally have to pay a premium to acquire the existing mortgage because it offers a higher rate of return than could be realized from originating a new mortgage. Conversely, when an existing mortgage carries an interest rate below the prevailing market rate, the purchaser will generally purchase the existing mortgage only if the price is discounted to provide a rate of return comparable to that available through the origination of a new mortgage. GNMA mortgages and the opportunity to originate mortgages must compete for investors with other market instruments. Thus, all mortgages, both new and existing, must provide yields comparable to other market instruments if they are to attract investors. Prevailing mortgage interest rates generally reflect the yield necessary for mortgages to be competitive. The difference, therefore, between the interest rate of GNMA mortgages and the prevailing market rate is a major determinant of the price that GNMA will receive from the sale of mortgages and securities. The greater the difference (prevailing rate exceeding GNMA mortgage interest rate), the greater the loss that GNMA will incur from the sale. This is illustrated in the following table by showing the discount required to sell $1 million worth of 7.5 percent mortgages with 12-year maturities under different market interest rates. 30 Prevailing market interest rates (percent) 8 8.5 9 9.5 Value of GNMA mortgages $1,000,000 $1,000,000 $1,000,000 $1,000,000 Interest rate - GNMA mortgage 7.5 7.5 7.5 7.5 Percent discount required to pro- vide comparable yield on mort- gages at the pre- vailing market rate 3.8 7.4 10.9 14.1 Amount of discount $38,000 .74,000 $109,000 $141,000 Selling price $962,000 $926,000 $891,000 $859,000 Therefore, in order to minimize its losses, it is extremely important that GNMA avoid selling mortgages at times when prevailing market interest rates, and thus, yields sought by investors, are excessively high in comparison to the interest rates of mortgages in the GNMA portfolio. To observe GNMA's sales activity in relation to the prevailing market interest rate for mortgages, we developed the following graph. The graph presents GNMA sales by month and the average monthly interest rates on conventional first mortgages covering the period July 1972 through December 1975. 31 U I Z - U,- , \ UJ NN f 0 \ Z -- oZI- ()0C z · US " E U _ _ r UJ o 32 Generally the graph indicates that GNMA increased sales of mortgages and securi ies when mortgage interestits rates were relatively stable or declining and decreased sales when mortgage interest rates were increasing. its fore, within the confines of the OMB outlay ceiling, There- appears to have timed its mortgage and security sales.GNMA relatively well. OMB outlay ceiling The sale of mortgages and mortgage-backed securitie heavily influenced by OMB-imposed limitations on GNMA's is net outlays for the fiscal year. Net outlays represent difference between GNMA's expenditures (i.e., mortgage the purchases, interest on Treasury borrowings, and operating costs), and revenues (i.e., mortgage portfolio revenues proceeds from sales). The level of GNMA's outstanding and borrowings will be increased by the amount that its expendi- tures exceed its revenues and these net outlays add national debt. to the GNMA, in developing its budget request, estimates expenditures for the fiscal year, its anticipated its revenues sources other than sales, the level of sales revenues, from its total outlay ceiling. Important factors in GNMA's and mate of sales revenues are the prices it can expect esti- to receive for mortgages and securities sold and the knowledge that OMB expects GNMA to sell as many mortgages as is feasible. GNMA's budget request is reviewed by the Secretary HUD and incorporated into the total HUD budget. OMB of the GNMA budget considering its appropriateness given reviews current economic conditions, such as housing starts the impact of GNMA's outlays on the national debt, and and the approves a total outlay ceiling. Once OMB approves the total outlay ceiling, GNMA attempts to sell to meet that ceiling. GNMA continually attempts to identify a demand for its mortgages and when a demand is identified. sells While it is impossible to predict that interest rates will eventually decrease, past history (see chart of interest rates on page 32) shows that there have been periods decreases in interest rates have occurred. where GNMA's flexibility to hold mortgages during periods when interest rates are relatively high is restricted, ever, by OMB's required end of the fiscal year outlay how- ceiling. If the outlay ceiling remains firm, GNMA forced to sell mortgages at excessively high yields may be to 33 attract investors in a high interest rate market. During fiscal year 1975 a critical situation developed whereby adherence to the outlay ceiling would have required GNMA to sell substantial amounts of mortgages or securities during periods of unfavorable market conditions. Ducing the fiscal year GNMA's expenditures exceeded their initial budget estimates due to substantial purchases made pursuant to the Emergency Home Purchase Assistance Act of 1974. Therefore, GNMA needed to sell about $3.2 billion worth of mortgages during the fiscal year to stay within the budgeted outlay ceiling. However, prevailing market interest rates during fiscal year 1975 were generally in excess of 8.75 percent. To avoid the potential large losses that would result from GNMA mortgage sales, OMB allowed GNMA to increase its budget outlay ceiling by $1.9 billion. GNMA, therefore, only had to sell mortgages totaling $1.4 billion in fiscal year 1975 for which it received revenues of $1.3 billion. FNMA and FHLMC sell mortgages in the secondary mortgage market and exercise complete control over their sales opera- tions. According to FNMA and FHLMC officials, they generally do not sell hen the yields of mortgages in their portfolios are less thar the yields required by investors. DISPOSITION OF MORTGAGES GNMA disposed of single and multifamily mortgages for total revenues of $9.1 billion during the period July 1, 1972, through March 31, 1976. These mortgages had an unpaid principal balance of $10.2 billion. However, the amount for which the mortgages were sold should not be deducted from the unpaid principal balance of the mortgage to arrive at the loss to GNMA because GNMA generally acquired the mortgages at a discount. A discussion of the sales of single and multifamily mortgages follows. Disposition f single family mortgages During the period July 1, 1972, through March 31, 1976, GNMA's sale of single family mortgages produced revenues of $8.2 billion. The sale of these mortgages was made under a variety of methods. The following table shows the unpaid principal balance of mortgages sold by method of sale for fiscal years 1973 through March 31, 1976. 34 ,-- C °%C 0 i0 ~ CC ,- LA LnA 0 0o- CL 4 QI vn MIv;,;J - E o, U- - o m . . L . L . to I .- Cl - N Lc O tY '.OeN I CO LA N LA 0 Er -0 - o8 ts I - -oC:, a r- Vt I _ _ O LA cv _ I 0 'D r' r- r- Z'- n. I-- 0 ·0, ''- z E - oI LL - -o Ic I L. N J V7, C . O 1 0 g CD I oz~v I Ner43 z 1 I Lt_ LA Ve I r - ,15 During fiscal year 1976 single family mortgage dispositions have been made by -- whole loan auctions, -- security auctions, -- portfolio repurchases, and -- negotiated sale to FNMA. Security auctions GNMA currently disposes of single family FHA and VA mortgages primarily through security auctions. Under the security auction method, GNMA selects a number of mortgages, referred to as a block, bearing the same interest rate from its portfolio. Each block must contain mortgages with a minimum aggregate unpaid principal balance of $1.1 million and must be serviced by only one mortgage servicer. The titles of mortgages in each block are transferred back to the originator and GNMA issues securities that are backed by portions of blocks and/or blocks of mortgages. Each issue of securities has a face value equivalent to the aggregate unpaid principal of the block of mortgages backing it. When it holds a security auction, GNMA generally offers a number of security issues for sale and requires the bidders to submit bids for the total amount of the security issues being offered. Bids on individual security issues are not accepted. GNMA sells on an all-or-nothing basis to save the administrative costs of handling numerous bids and to assure the sale of all the security issues. GNMA began holding security auctions in January 1975, and through March 31, 1976, it has sold $3 billion through this method producing revenues of $2.8 billion. Although the amount of securities sold and the revenues resulting from the sale are shown, the loss cannot be computed from these two figures because of the varying discounts at which GNMA obtained the mortgages. The amount of securities is the unpaid principal balance that the securities represent, which is generally not the cost to GNMA of the mortgages since most mortgage purchases involve a discount and fees, as discussed on page 14. The foregoing also relates to the other instances in the report where we show the amount of a sale of GNMA mortgages and the revenues received in the sale. This represents 42.6 percent of all FHA and VA single family mortgages sold between July 1, 1972, and March 31, 1976, and 85.9 percent of all FHA and VA single family mortgages sold since January 1, 1975. All of these securities were purchased by two large syndicates and immediately offered for sale by the syndicates as individual securities. 36 GNMA officials told us the following advantages overthat the securities auction has whole mortgage sales: -- It provides GNMA greater assurance achieving a yield on its investment that it is accurately reflects current which more market conditions than is possible through the price. administratively set -- It provides GNMA with a highier securities are tradeable and yield because attractive than mortgages. are, therefore, more Whole loan auctions In certain situations, GNMA is unable to dispose of single family FHA and VA mortgages This can occur when GNMA does through security auctions. of mortgages from a single not hold a sufficient amount originator at the same interest rate to put together a block of these mortgages with the required minimum aggregated unpaid Another situation is when GNMA balance of $1 million. through a security auction wants to sell mortgages but the mortgage originator not to participate. elects When either of these situations exists, GNMA will generally sell these mortgages to the highest bidders. A wholethrough whole loan auctions the submission of bids for the loan auction provides for immediate purchase of a mortgage or package of mortgages. maximum price he will pay for The investor's bid is the sell the mortgage(s) to the the mortgage(s). GNMA will highest bid will produce the highest bidder provided that the minimum yield acceptable to GNMA. During the period July 1, 1972, single family mortgages worth through March 31, 1976, method producing revenues of $4.1 billion were sold by $3.7 billion. This accountsthis for 44.9 percent of the value sold during this period. of all single family mortgages Mortgage repurchases from poltfolio As discussed in chapter 2, GNMA in selling conventional mortgages experienced difficulty GNMA's optional repurchase program to private investors. has substantially reduced the (assumption of commitments) GNMA must purchase; however, number of conventional mortgages GNMA had still purchased conventional mortgages totaling 1976. To reduce its portfolio $3 billion as of March 31, GNMA offered these mortgages of conventional mortgages, back to their originators at 37 current market prices determined by GNMA during January and February 1976. Since GNMA had purchased the mortgages at prices close to par (100) from the originators, the repurchase by the originators of the mortgages at current market rates, which were below par, resulted in the origin- ators paying less to GNMA for the mortgages than GNMA paid to the originators. AS of March 31, 1976, GNMA had sold mortgages totaling $1.1 billion by this method, producing revenues of $1 billion. Negotiated sale to FNMA In March 1976 GNMA sold conventional single family mortgages to FNMA totaling about $775.5 million for revenues of $715.8 million. GNMA and FNMA negotiated the price for conventional mortgages which originators had delivered to GNMA but which GNMA had not completely reviewed. GNMA made the ale because, according to GNMA officials, FNMA paid a better price for the mortgages than repurchasers were paying. GNMA officials used a comparison of the yield based on FNMA's price with the yield paid by repurchasers for conventional mortgages. Disposition of multifamily mortgages GNMA has had difficulty in selling its multifamily mortgages. A GNMA official suggested the reasons for this were the 40-year maturities of the mortgages and the high yield required by savings and loans on such mortgages. In attempts to sell multifamily mortgages, GNMA has tried four different methods: whole loan auctions; tandem; option sales; and an option auction. The methods that GNMA used to dispose of mortgages in 1975 and 1976 are discussed in the following. The following table shows the unpaid principal balance of multifamily mortgages sold by method of sale and fiscal year for the period July 1, 1972, through March 31, 1976. GNMA received revenues of $897.3 million for these mortgages; however, as discussed on page 34, the revenues received should not be deducted from the unpaid principal balance to arrive at a loss to GNMA. 38 4 4- O(I tJE to r C c 4 d) |tD .a or a ,D 00 - to ts. I tO O - > a a 44 Ln Us , uI QD °1 .rr -pN U , I Co - U) a.- t c iI P. -J E CD 4) tn - I F1 LfU L L C) LL. ~ cm 44 ( z I hu e ar h V h;~~ h ~ a O* 01~L- V r'U I an^ 0 3 an 'U cu i o~~~~ U)I C a) 0J 4.) 4. ad 4- = .0 o ~ v ~~4JZ Z - ad) 4-) v 4.) ~ z 4) 'C; ~ U - QE 39L ~ 39 Whole loan auction Before October 1975 GNMA sold its multifamily mortgages primarily through the whole loan auction method. Through October 1975 a GNMA official estimated GNMA had been able sell only about 35 percent to of the total multifamily it had purchased. Between July 1, 1972, and March mortgages a total of 373 multifamily 31, 1976, mortgages worth $676.1 million had been sold by this method producing revenues of $561.4 million. Option sales In October 1975 GNMA initiated the sale of FHA multifamily mortgages by the option sales method. Under this method GNMA administratively could immediately purchase set a price at which an investor a multifamily mortgage or, fee, obtain a project mortgage for a purchase option. The option extended the investor's right to purchase the subject mort- gage within 60 days at the established price. The option sale lasted only 1 week. GNMA closed sales when market interest rates began declining. Because of the uncertain market situation, the continued sale of the mort- gages at an administratively set price could have resulted in the sale of mortgages at unreasonably large discounts. Ninety-four mortgages worth method producing revenues $220.8 million were sold by of $167.0 million. this Option auction On March 4, 1976, GNMA began mortgages through an auction selling multifamily method which it terms an "option auction." Announcements of such auctions by GNMA to submit mortgage provide invitations bids and mortgage option applica- tions. When accepted, a mortgage to the bidder the right to option application extends purchase the mortgages at the specified on the option application price accepting both types of bids within 2 months. By competition between investors,GNMA hopes to increase the thus providing GNMA with higher prices for its mortgages. All bids and cption applications are evaluated on an open competitive basis, but GNMA reserves the right of tion. Bids and options are evaluated rejec- each other; however, a bid in competition with for a specific mortgage might accepted in preference to an be option application which speci- fies he same mortgage and a higher ',urchase price. mortgages receiving both bids For the administratively determined and option applications, GNMA would be accepted when the that the option applications option bids exceeded the purchase 40 bids by at least 1.85 percentage points. For example, one project mortgage GNMA received an option applicationfor of 82.4000 and a mortgage bid of 81.0100. bid (By a bid of 82.4000, the bidder is agreeing to pay 82.4 percent 'of the unpaid principal.) Since the option application exceeded the mortgage bid by only 1.3900, the mortgage bid was accepted over the option application. GNMA was pleased with the results of the March 4, 1976, auction in which it accepted $156.2 million worth of purchase bids for 116 mortgages worth $188.1 million and option bids for 49 mortgages totaling $115.9 million. DETERMINATION OF SALES PRICE All of GNMA's methods of selling mortgages or securities involve its estimation of the current market price. For mortgage-backed securities, whole loan, option auctions, the negotiated sale to FNMA the estimated current market ad price is used s a guideline in determining the minimum acceptable bid. The actual selling price for those methods is determined by the bids received. However, for the remaining two methods of disposition--the single family conventional repurchase method and the multifamily option sale method, the slling price is determined by GNMA's esti- mation of the current market price rather than by competitive bid. GNMA estimates the current market price by reviewing mortgages, securities, and other instruments comparable to those it is offering for sale. For example, when GNMA decides to sell mortgage-backed securities it reviews the current yields being offered by GNMA securities trading in the second- ary market, Treasury bonds, mortgages sold by FNMA, and FHLMC's participation certificates. These instruments are similar to GNMA's securities in that they provide limited risk and are highly marketable. In analyzing the yields of other comparable instruments, GNMA officials weigh the yields' significance cn the basis of their knowledge of market conditions, including the of active investors. desires An additional factor which impacts on the establishment of the price is GNMA's desire to sell a sufficient amount of mortgages or securities to meet OM3's outlay ceiling at year end. Based on the aforementioned factors, GNMA subjectively sets the minimum acceptable price or sales price. GNMA officials told us that there is no set formula for establishing the exact price. Similarily, an official at FNMA advised us that FNMA does not have a set formula fr establishing prices of mortgages it plans to sell. 41 FHLMC officials, however, stated that FHLMC does have set formulae based on the yields of mortgages in its portfolio plus a guarantee and management fee. YIELDS ON GNMA'S AND OTHER FINANCIAL INSTRUMENTS Many variables and subjective considerations enter into a comparison of the reasonableness of the yields of financial instruments. Because of these variables, we were not able to answer the question: Are the yields on GNMA mortgages and securities reasonable? To provide some indication of the reasonableness of the prices GNMA is receiving from its sales of mortgages and securities, we compared the yields provided by GNMA mortgages and securities with the yields provided by other selected financial instruments. Each instrument we identified has its own characteristics (i.e., low risk, highly marketable, monthly payments, etc.), the combination of which make the instrument distinct from other instruments. We were unable to identify any instruments with exactly the same characteristics as GNMA's conventional single family mortgages, FHA multifamily mortgages, or mortgage-backed securities. (FHA and VA single family mort- gages are not presented because of the limited number of such sales since the implementation of security auctions.) The yield an investor requires to purchase an instrument varies depending on his perception of the advantages and disadvantages of the nstrument's characteristics. Thus, different types of instruments attract different types of investors. According to our discussions with financial experts, to determine a range of reasonable yields for GNMA's mortgages and securities would be extremely difficult, and at best only an estimate. Each istrument's characteristics which differ from those of GNMA's instruments would have to be weighted to establish comparability. Assigning weights to an instrument's characteristics is extremely subjective; for example, state- ments by several financial authorities on the value of a Government guarantee to an investor vary from zero to one-half of 1 percent, depending on the status of he economy and the investors involved. Although we were unable to make an unqualified conclusion as to the reasonableness of GNMA's yields, we did select several instruments with some characteristics similar to those of GNMA's mortgages and securities and generally found their 42 yields to average within 50 basis points 1/ of GNMA's mortgages and securities yields. Because GNMA's conventional single family mortgages, multifamily mortgages, and mortgage-backed securities FHA or VA single family mortgages) have some significantly (FHA ent characteristics, we compared each one separately differ- with other instruments having similar cussed in the remainder of characteristics. The yields dis- this section represent monthly averages for all issues sold during the month instruments with various face interest rates and represent and maturities of 10 years or more. GNMA mortgage-backed securities Mortgage-backed securities sold by GNMA were compared to (1) Treasury Bonds, (2) mortgage-backed securities teed by GNMA but sold by originators, and (3) guaran- the composite of Federal Insured Securities (insured securities issued by various Federal agencies) for the period January March 1976. These securities were selected 1975 through because have at least the following similar characteristics: they all -- Guaranteed by the Government. -- Marketability (are easily resold to other investors). -- Payments of principal and interest are made monthly. Mortgage-backed securities sold by GNMA provided to investors similar to those of mortgage-backed yields securities guaranteed by GNMA and sold by originators, and of long-term Government securities in that they the composite averaged only 10.3 and 30.9 basis points higher respectively. securities' yields, however, were significantly GNMA U.S. Treasury Bond yields, averaging 154.7 basis higher than monthly for the period reviewed. A GNMA official points private economist suggested several reasons and a for this. They stated GNMA securities -- are relatively new to the market, thus investors are not as comfortable with them; -- are subject to fluctuating payments caused by lump sum payments on defaulted or repaid mortgages within the pool; and 1/ A basis point is equal to .01 percent. 43 -- have inconsistent maturities due to defaults and early repayments. On the other hand the GNMA official said that Treasury bonds are subject to none of these restrictions Government guarantee and other attractive yet have the characteristics of GNMA securities. GNMA's multifamily mortgages FHA multifamily mortgages sold by to FHLMC's Participation Certificates GNMA were compared and the composite of Federal Insured Securities for the period 1976. FHLMC's Participation Certificates May 1975 to March by the Government but are guaranteed by are not guaranteed similar to GNMA's mortgages in their low FHLMC and are degrees ability and monthly repayments of principal of market- The composite is similar to GNMA's mortgages and interest. in represent instruments insured by the Government. that both GNMA's multifamily mortgages provided from 25 to 115 basis points higher than yields which range Certificates and 28 to 159 basis points FFILMC's Participation more than the composite of long-term Government securities. A economist suggested that GNMA mortgages GNMA official and an because they require higher yields -- have varying maturity dates due to defaults and early repayments, -- require evaluation by a knowledgeable assess their soundness, and staff to -- are difficult to resell and thus provide liquidity. little These officials said that the impact factors on selling price is a subjective of these and other therefore, difficult to quantify. Also, determination and, were conducted, thus providing limited only eight sales experience. GNMA's conventional single family mortgages GNMA's conventional mortgages' yields to compared to the yields of FHLMC's Participationinvestors were and Aaa corporate securities 1/ for the Certificates 6 months such sales 1/ These are securities of companies that specialists in the financial community consider to be the most credit worthy. 44 had been made at March 31, 1976. All thrce instruments lack a Government guarantee which means there is some risk involved to the investor. FHLMC's Participation Certificates are similar to GNMA's conventional mortgages in that both make payments monthly which include principal and interest, the mortgages involved are primarily conventional, and the instruments are considered difficult to market. Some Aaa corporate securities make monthly payments but others are paid quarterly or annually. GNMA's conventional mortgages provide yields which average 26.0 basis points more each month than FHLMC's Participation Certificates and 27.8 basis points more than Aaa corporate securities. ATTRACTION OF ONTRADITIONAL INVESTORS An additional objective of GNMA is to attract new capital into the mortgage market. One way this is accomplished is by encouraging new (nontraditional) investors to invest in the mortgage market. Traditional mortgage investors are organizations which regularly originate and/or purchase mortgages, such as savings and loans, mortgage bankers, and FNMA. Participa- tion by these members does not assume the addition of any new capital into the mortgage market since they are already active in mortgage financing. Nontraditional mortgage investors are organizations such as pension and State retirement funds, which do not normally invest in home mortgages because of legal and/or policy restrictions. These restrictions vary by organiza- tion but generally require instruments purchased to have -- a high degree of marketability, -- limited risk, and -- limited servicing and management requirements. To determine the success of various GNMA instruments in attracting nontraditional sources of mortgage investment capital, we identified initial investors by type and degree of participation for GNMA securities and mortgages sold from July i, i972, through March 31, 1976. However, any conclu- sions drawn from the results of our survey must be qualified because some of these traditional organizations, such as mortgage bankers, may resell the mortgages they purchase to nontraditional investors. Conversely, some nontraditional investors sell to traditional investors. Our analysis showed 45 that GNMA has been more successful in attracting nontraditional investment capital through the sale of GNMA-held mortgages and by guaranteeing securities backed by mortgage originators than through the securities issued by gages. The results of our analysis sale of individual mort- are presented in the following. GNMA securities A GNMA official said that various regulations permit GNMA securities to qualify as and rulings pension and retirement funds, Federal legal investments for credit unions, national banks and other members of the many State-chartered banks and Federal Reserve System, and insurance companies. All such institutions, together with corporations, trusts, and individuals, are investors partnerships, in In addition, GNMA securities are guaranteed the securities. Government, are treated as a mortgage by the Federal for tax are highly marketable--three characteristics purposes, and tional investors find attractive and which nontradi- in some cases require. The syndicates which sell GNMA securities GNMA-held mortgages furnished the amounts backed by sold by class of purchaser for three of securities they million, which was 15.0 percent of sales totaling $457.7 total mortgage-backed securities sold from January 1, 1975, The following table lists percentages through March 31, 1976. of the three offerings purchased by initial investors. Types of investors Percent purchased Traditional mortgage investors: Thrift institutions (i.e., savings Commercial banks and loans) 23.91 14.32 Total 38.23 Nontraditional mortgage investors: Insurance companies (note a) Pension and State Retirement Funds 5.05 Credit Unions 52.72 All others (i.e., bond funds, investment 1.14 firms) 2.86 Total 61.77 Grand total 100.00 a/ Insurance companies are traditional mortgages but invest in a few single investors in multifamily family mortgages. 46 GNMA identified the initial investors in pass-through securities /sold by issuers and guaranteed by GNMA for the $23.3 billion worth of mortgage-backed securities outstanding as of March 31, 1976. The following table lists the percentage of securities purchased by initial investors. Percent Types of investors purchased Traditional mortgage investors: Thrift institutions (i.e., savings and loans) 41.17 Commercial banks 4.52 Mortgage bankers 19.58 Total 65.27 Nontraditional mortgage investors: Pensions and State Retirement Funds 8.29 Individuals 1.19 Credit Unions 3.08 All others (i.e., bond funds, investmentu firms) 22.17 Total 34.73 Grand total 100.00 GNMA mortgages GNMA does not attract nontraditional mortgage investors through either its auctions of FHA-insured or VA-guaranteed mortgages or its sale of nonguaranteed conventional mortgages. Our analysis of a statistical sample 2/ of FHA and VA mortgage sales totaling about $4 billion made between July 1, 1972, and June 30, 1974, showed that mortgage bankers pur- chased 89 percent of such mortgages and FNMA purchased 11 percent. Our analysis of five sales totaling $511.3 million made between July 1, 1974, and March 31, 1976, showed that mortgage bankers and thrift institutions purchased about 91 and 9 percent, respectively. Investors in conventional mortgages were either FNMA or originators who bought back their mortgages through 1/ Investors in GNMA securities sold as bonds could not be identified by GNMA. 2/ The sample has a confidence level of 95 percent. 47 repurchases from GNMA's portfolio (GNMA's Repurchase Program). Of all sales of conventional mortgages totaling $1.8 billion made through March 31, 1976, FNMA purchased about 41 percent, with thrift institutions (i.e., savings and loans), mortgage bankers, and commercial banks purchasing the remaining 59 percent. MANAGEMENT AND LIQUIDATION OF ACQUIRED MORTGAGES GNMA is also responsible for managing and liquidating certain federally owned mortgages with effect on the home mortgage market and a minimum adverse a minimum loss to the Government. These mortgages were originally owned by the dissolved Reconstruction Finance Corporation and HUD, and were transferred to GNMA upon its creation. Liquidation of the mortgages is accomplished through regular principal repayments, by sales of mortgages to private investors, and by prepayments and foreclosures. GNMA has not purchased or sold any mortgages under this function since fiscal year 1973 when 68,558 mortgages with a principal value of $716.6 million were sold at million. a discount of $93.9 The mortgage portfolio under the management and liquidating function had an outstanding balance of $340.9 million on March 31, 1976. TRUSTEE OPERATIONS GNMA manages the assets and liabilities of three trusts and is the guarantor of payments on the participation certi- ficates the trusts issued. The three trusts are the Govern- ment Mortgage Liquidation Trust, the Federal Assets Liquidation Trust, and the Federal Assets Financing Trust. The agencies participating with GNMA as trustors in one or more of the three trusts are (1) the Farmers Home Admini- stration, (2) the Department of Health, Education, and Welfare, (3) the Department of Housing and Urban Development, (4) the Veterans Administration and (5) the Small Business Administration. These participating agencies conveyed title to assets (mortgages and housing-related debt instruments) to the three trusts for which the GNMA is trustee; retained control and administration of however, the agencies these assets. Then the trustee issued and sold to private investors participation certificates backed by these assets. The last sales were in 1968. The agencies used the proceeds from these sales to 48 reduce funds borrowed from the Treasury and to reduce the use of Government funds for their programs. Certificates outstanding at June 30, 1975, totaled $4.2 billion. As trustee, GNMA receives from the trustor agencies the principal and interest collected on the assets, less the agencies' service charges. These funds are used to pay interest on the participation certificates, pay trust expenses, and retire participation certificates at maturity. If these funds are not adequate, GNMA requests additional funds from the trustor agencies. Specific appropriations are avail- able to the trustor agencies for payment of participation sales insufficiencies. In the Government Mortgage Liquidation Trust, five issues of participation certificates, totaling $1.8 billion, have been sold since the trust was established. The last issue was sold in 1966. During fiscal year 1975 certificates totaling $110 million were redeemed. The outstanding balance of the certificates was $770 million at June 30, 1975. The certificates will mature at various times through 1981. Collections received during the fiscal year were sufficient to cover interest due on the certificates. In the Federal Assets Liquidation Trust, four issues of participation certificates, totaling $3.2 billion, have been sold since it was established. The last issue was sold in 1968. During fiscal year 1975, no certificate redemptions were made. The outstanding balance of the certificates was $1 billion at June 30, 1975. The certifi- cates mature at various times through 1987. Because net interest earned on the assets and cash deposits held for the trustors were less than the interest expense incurred on the certificates, additional contributions of $7.6 million were made to the trust by the trustors. In the Federal Assets Financing Trust, four issues of participation certificates, totaling $4.3 billion, have been sold since the trust was established. The last issue was sold in 1968. The certificates will mature at various times through 1988. During fiscal year 1975, certificates totaling $12.4 million were reacquired. The outstanding balance of the certificates was $2.4 billion at June 30, 1975. Because net interest earned on the assets and cash deposits held for the trustors were less than the interest expense incurred on the certificates, additional contribu- ticns of $31.1 million were made to the trust by the trustors. 4 CHAPTER 4 ALTERNATIVES TO PRESENT MORTGAGE SALES PRACTICES This chapter discusses several alternatives for improving GNMA's present practices of disposing of mortgages and mortgage-backed securities. They are -- selling the Association's mortgages directly to the Federal Financing Bank, and -- obtaining greater benefit from mortgage-backed securities by (1) permitting investors to bid on individual security issues rather than on all of the security issues offered and (2) reducing the minimum amount of the security issue to some amount less than $1 million. These alternatives were discussed in our testimony on September 20, 1976, before the Senate Committee on Banking, Housing and Urban Affairs. In a report dated November 29, 1976, (CED-77-16) to the Secretary of HUD, we recommended that the desirability of implementing the alternatives be determined. AN ALTERNATIVE TO PRIVATE MARKET SALES The sale of GNMA mortgages to the Federal Financing Bank would allow GNMA to adhere to the OMB-imposed outlay ceiling while at the same time eliminate the need to sell the mortgage in the private market under unfavorable condi- tions, thereby providing a potential opportunity to minimize losses. The Federal Financing Bank was created by the Federal Financing Bank Act of 1973 (P.L. 93-224), as part of the Department of the Treasury. It is authorized to purchase and sell, on its own terms, any obligations or guarantees issued by any executive department, independent Federal establishment, corporation, or other entity created by the Congress, which is owned in whole or in part by the United States and authorized to sell obligations. Its purpose is to lower the cost of borrowing for those Federal agencies that raise funds in the private market by selling various financial instruments directly to private investors. This is possible because the Bank is able to pay a bette: price for these securities than could be received in the financial markets. Participation by eligible agencies is voluntary. The Bank funds its purchases either by issuing its own obligations or by selling its securities directly to the 50 Treasury, which, in turn, would sell its own obligations to raise the funds. Because the Bank is a part of the Treasury its obligations are expected to sell at close to the rates obtained on Treasury offerings, which are the most attractive Federal financial instruments and the least costly form of Federal borrowing. For the most part, the Bank's purchases have been funded through the sale of its own securities directly to the Treasury. GNMA was authorized to sell mortgages and mortgage-backed securities to the Federal Financing Bank by amendments in 1974 and 1975 to the National Housing Act. The Emergency Home Purchase Assistance Act of 1974 added a new section to the National Housing Act authorizing GNMA to sell mortgage-backed securities to the Bank. The Emergency Housing Act of 1975 further amended the National Housing Act by authorizing GNMA to sell mortgages and securities to the Bank and by directing the Bank to purchase any such mortgages or securities offered by GNMA. The 1975 amendment follows: "* * The Association may offer and sell any mortgages purchased or securities guaranteed under this section to the Federal Fnancing Bank, and such Bank is authorized and directed to ourchase any such mortgages or securities offered Ly the Association." However, through the end of fiscal year 1976 GNMA had not sold any mortgages or securities to the Bank. Officials at the Bank and GNMA advised us that during early 1975 GNMA anl Bank officials held several meetings with respect to the details of such sales. However, GNMA and Bank officials dis- agreed on how long the Bank would hold the mortgages. GNMA favored a sale to the Bank which would then resell the mort- gages to the private market in the near future while the Bank favored long-term holding of the mortgages. According to cor- respondence between GNMA and OMB in July 1975, OMB made the decision that mortgages would not be sold to the Bank at tnat time. Instead OMB increased HUD's outlay ceiling so that GNMA would not be forced to sell the mortgages at that time. In a memorandum dated June 27, 1975, from OMB to HUD approving the increase in HUD's outlay ceiling by el.9 billion for fiscal year 1975, OMB stated that "Unfortunately, an increase in the allowance is necessary because of GNMA's inability to dispose of the mortgages purchased under the FHA-VA and conventional tandem plans as originally planned." 51 The memorandum also stated that OMB did not learn of GNMA's inability to sell these mortgages until May 27, 1975, and that options availabl- to dispose of mortgages were unattractive which made an increase in the outlay ceiling necessary. Because of the OMB-imposed outlay ceiling, GNMA may find it necessary to sell mortgages in the private finan- cial market even though market conditions might not be particularly favorable at the time of the proposed sale (i.e., interest rates increasing). By selling its mort- gages and mortgage-backed securities directly to the Federal Financing Bank rather than to private investors, GNMA could get a better price for the mortgages and securities, and the Bank could hold them and wait for more favorable market conditions before selling. In addition to the opportunity of minimizing the Federal Government's loss, the use of this alternative could have a positive influence on GNMA's efforts to encourage more mortgage originations. Generally, GNMA needs to sell mortgages to finance its mortgage commitment and purchase activities which are undertaken to stimulate mortgage originations. However, the majority of GNMA mortgages offered for sale are purchased by mortgage bankers and savings and loans who are the principal mortgage originators. (See p. 47.) Consequently, at approximately the same time GNMA is making commitments and purchasing mortgages to stimulate mortgage originations, it is selling existing mortgages to the principle mortgage investors. The net result is that the sale of existing GNMA mortgages to mort- gage originators reduces the amount of capital available for mortgage originations and may very well be counter- productive. The sale of the mortgages directly to the Federal Financing Bank provides the opportunity to delay and possibly preclude the sale of mortgages so that they would not be in competition with GNMA's market stimulation efforts. Two possible negative features of the sale of mortgages to the Federal Financing Bank are: -- Because the Bank finances its purchases by Treasury borrowings, the purchases of mortgages by the Bank would result in a direct increase in the public debt. -- If market conditions continued to worsen (i.e., interest rates continued to rise), the Federal Financing Bank might be forced to sell the 52 mortgages at a greater loss than GNMA would have incurred in order to avoid long-term losses. In our letter dated May 25, 1976, to the Chairman, Senate Subcommittee on Housing and Urban Affairs, we dis- cussed the matter of indirect costs as a result of Federal financing of certain housing programs. We pointed out that financial experts at several Federal agencies told us that there were no techniques or models that could measure the indirect costs to the Federal Government as a result of direct borrowing. They said that much more study and research remained to be done on the development of economic analytical techniques concerning indirect costs. OPPORTUNITY TO OBTAIN MORE COMPETITION IN SALES ACTIVITIES The sale of securities backed by GNMA held mortgages is preferred by GNMA to the sale of individual mortgages because they -- are more marketable and, thus, easier to sell; -- attract a higher price than would the mortgages themselves; and -- attract nontraditional mortgage investors. GNMA sells its securities through closed bid auctions. Since January 1975, GNMA has held 17 such auctions by which it sold $3 billion worth of securities for $2.8 billion (a discount of 9.1 percent). On the other hand, during the same period, GNMA sold $501.8 million worth of single family mortgages through whole loan auction sales, for which it received $455.1 million (a discount of 9.3 percent). GNMA officials cited two reasons for not selling these mortgages as mortgage- backed securities. They said that their procedure requires that issued securities have a minimum face value of $1 million ad that -- issuers net worth, in assets acceptable to GNMA, is sufficient to meet specified Government regulations, -- the mortgages are insured by FHA or guaranteed by VA, 53 --the issuers provide for servicing and timely payment of interest, and -- issuers comply with other similar regulations. GNMA holds mortgages from many different originators but not always in sufficient quantity to satisfy the $1 million mini- mum requirement. In addition, GNMA officials said that some originators elect not to participate in a security issue. According to a GNMA official, the most commonly traded mortgage-backed securities, issued by mortgage originators and guaranteed by GNMA, are securities valued at $100,000 and $1 million. Thus, if GNMA were able to sell securities valued at $100,000 it might be able to dispose of more of its mortgages through security sales and reduce the number of mortgages that it had to sell. The benefits of reducing the minimum value would be twofold: GNMA should be able to get a better price by disposing of the mortgages as securi- ties; and by se'ling them as securities it makes them attract- ive to nontraditional mortgage investors. GNMA oficials indicated that GNMA could have sold as securities some of the $501.8 million worth of mortgages it sold through whole loan auctions since January 1975 if the minimum value requirement was $100,000. POTENTIAL SAVINGS THROUGH THE DIRECT SALE OF SECURITIES TO PRIVATE INVESTORS When GNMA holds a security auction, it is offering a number of security issues for sale with the requirement that the potential investor must submit a bid for the entire block. As of March 31, 1976, this requirement has had the effect of limiting competition on security auctions to two large syndicates. At this date only two large syndicates have submitted bids at GNMA security auctions and thus all of the securities offered were purchased by the two syndicates. The blocks of securities sold at these auctions have ranged from $69.0 million to $305.G million. The purchasing syndicates resold the securities in smaller amounts to private investors, acting in effect as middlemen between GNMA and the private investors. In most cases, according to GNMA officials, the syndicates had obtained commitments from the private investors for the purchase of the securities before the sydicates' purchase of the securi- ties from GNMA. For all security sales through March 31, 1976, the syndicates paid GNMA $2.8 billion for the securities and resold them for a gross profit of $15.5 million (.56 percent of the purchase price), or an average gross profit of $912,000 per auction. 54 According to GNMA officials, GNMA intends to continue selling its securities in the above manner because it feels that through the syndicates marketing efforts it (1) can reach investors at a reasonable cst with minimal administra- tive effort on GMA's part, (2) is assured of receiving a fair market price for its securities, and (3) receives a higher price by selling all the securities together. The opportunity exists for GNMA to increase its revenues on the sale of mortgage-backed securities if it revises its bidding procedures to permit potential investors to bid on individual security issues rather than requiring the indivi- dual investor to bid on the entire block of security issues. This contention is based upon the following factors: -- Mortgage-backed securities guaranteed by GNMk have become well known and are readily marketable in the financial market. As of March 31, 1976, GNMA was guaranteeing approximately $23 billion worth of such securities held by investors. -- The additional administrative cost to GNMA would be minimal. The acceptance of bids on individual security issues should result in a larger number of bids to be evaluated; how- ever, the only factor to be considered is the bid price, which should require only a minimal additional effort by GNMA. In addition GNMA already prints and issues the securities to the investors who purchase the securities from the syndicates. -- According to a GNMA official, the prices received for GNMA-guaranteed securities are generally the same regardless of the seller involved (i.e., GNMA, mortgage investor, or syndicate). This is because prior issues of GNMA securities are constantly sold in the financial market and investors can choose the best yielding securities. Thus, it is highly probable that GNMA could obtain the same prices that the syndicates obtain when they sell the GNMA securities. We recognize a possible negative effect ;_ NMA conducting such sales could be the failure to cract nontraditional lenders. As discussed on page 46, it appears to us that the syndicates have been more successful selling to nontraditional lenders, such as State pension and retire- ment funds, than have the originators in GNMA's guaranteed 55 mortgage-backed securities program. This could be accounted for by the fact that the State retirement funds prefer to purchase securities in large amounts ($50 million to $80 million in some cases), something individual originators cannot offer but the syndicates can offer. In this regard, GNMA could tailor the size of its offerings to take advan- tage of individual investor preferences. According to several GNMA officials, GNMA has never attempted to determine the cost and feasibility of permitting investors to bid on individual security issues. In view of the fact that the syndicates' average gross profit per auction has been about $912,000, GNMA should determine the feasibility of permitting investors to bid on individual security issues. 56
Government National Mortgage Association's Secondary Mortgage Market Activities
Published by the Government Accountability Office on 1977-03-08.
Below is a raw (and likely hideous) rendition of the original report. (PDF)