DOCUMENT CUSTODY
mortgage bonds, mortgage servicing rights, repurchases, etc., makes up the secondary market, which is very liquid. The secondary market arises when,
as explained in a US government paper called ‘An Overview of the Housing Finance System in the United States’ (Congressional Research Services, January 2017), the originator of the mortgage sells it or securitises it. When a mortgage is securitised, it is pooled into a security with other mortgages, and the payment streams associated with the mortgages are sold to investors. Thousands of contracts can therefore be bundled together and marketed as a bond offering to investors. Other loans, such as automotive lending and credit card debt, are also securitised; asset-backed securities (ABS) occupy a smaller yet meaningful proportion of Deutsche Bank’s document custody business overall. The US housing market is largely supported by three agencies operating under one central charter to foster home ownership throughout the country. Fannie Mae (FNMA) and Freddie Mac (FHLMC) are categorised as GSEs under the conservatorship/guardianship of the Federal Housing Finance Agency. Ginnie Mae (GNMA) is seated within the Department of Housing and Urban Development (HUD), where its mortgages are insured and guaranteed by the federal government. None of these agencies originate or service the mortgages in their securitised pools. However, these agencies do set standards, provide oversight and manage service providers, as well as issuers and other service providers associated with these securitisations. The three agencies comprise around 90% of the secondary marketplace. According to the Congressional research paper: “What happens to a mortgage in the secondary market is partially determined by whether the mortgage is government-insured, conforming, or non-conforming. Depending on the type of mortgage-backed security (MBS) or mortgage purchased, investors will face different types of risks.” While the lender retains the direct
relationship with the borrower or homeowner, they often finance their lending through other financial institutions, often referred to as ‘warehouse lenders’ or ‘interim funders’. The mortgages are then securitised and/or sold to third parties, providing the mortgages qualify and there are no exceptions against the criteria established in agreements. Securitised loans wind up either in agency pools or non-agency (private) deals.
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Now, lending is a well-disciplined market and underwriting standards are solid
James Macmillan, Co-Head, Document Custody Services, Deutsche Bank
Total outstanding mortgage debt is
broadly estimated at around US$17.6trn in the US. Elevated inflation and higher interest rates are expected to weigh on economic growth and home sales in 2022, according to the Fannie Mae (FNMA/OTCQB) Economic and Strategic Research Group forecast. “Substantially higher mortgage rates are now the housing market’s primary constraint. The ESR Group expects total home sales to fall to 13.5% in 2022… and, correspondingly, for mortgage originations to move downward to US$2.6trn in 2022 and US$2.2trn in 2023,” the forecast outlines. Refinancing is a significant driver of the document custody business, yet refinancing origination activity continues to slow. As an offset, document custody is onboarding a wave of new clients, as
specific competitors no longer meet agency requirements and Deutsche Bank proves its unrivalled capability and size. “We have come a long way from the pre-crisis,” says the bank’s Document Custody Client Services Co-Head, James Macmillan. He adds: “Now, lending is a well-disciplined market and underwriting standards are solid. Furthermore, the housing market will remain strong, primarily because of historically low delinquencies, low inventory and high ownership demand, especially from millennials.”
Managing the documentation Handling loan documents across the range of parties involved in origination, warehouse lending and securitisation, over the life of the loan, is not straightforward. Not only does each underlying loan have its own contract or file (a home loan produces a file of key documents such as a note, mortgage and title, for example), the physical possession of the collateral file is also fundamental to the financing of the loan. Each time a security changes hands, further documentation is generated, and layers are added to the chain-of-custody and secured interest assignments. Despite significant moves towards digitisation, the US real estate industry nevertheless generates vast quantities of paper documentation. It operates across more than 3,000 County Recorder offices, allowing for varying degrees of electronic documentation,
Figure 1: Summary of documentary custody interactions
Closing table/ actual borrower
Lender
Buyer/agency S
Loan originator Custodian Source: Deutsche Bank
71
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