Eighth Edition - Covering 2006 Through 2008
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Eighth Edition - Covering 2006 Through 2008 |
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If there's one positive that can be said it's this: the mortgage industry is still standing. That doesn't sound good, but without a doubt the business of lending money to consumers so they can purchase a house is in the worst shape since the savings and loan crisis of 1986 - 1991. Some say, the Great Depression. We won't know the true answer to that question for a year or so. It's always better to judge things when your head is clear and right now there's too much smoke in the room to get much clarity. One thing's for certain: conventional (Fannie Mae/Freddie Mac) loan production and FHA (Federal Housing Administration) insurance is where the business is at in 2008 and 2009. No one can argue with that.
The days of gangbuster subprime production are over. Between 2004 and 2006 mortgage bankers originated $2.078 trillion in loans - most of which was securitized by Wall Street firms like Bear Stearns, Lehman Brothers, Greenwich Capital, Merrill Lynch and other investment banking firms. Looking back on the crisis, it's hard to believe that these Wall Street bluebloods once thirsted so mightily for risky mortgages just so they could package them into asset-backed securities (ABS) and collateralized debt obligations (CDOs), selling them to institutional investors overseas and abroad. As we note elsewhere in this book, the business of making mortgages to consumers with less-than-stellar credit is going back to its roots: low loan-to-value (LTV) ratios, thorough credit checks and careful appraisals. It will be a much smaller market. Very small. Perhaps, one day it will come back, but if it does, it will not be like the boom years of 2004 to 2007.
Meanwhile, in this chapter we're going to talk about industry trends affecting residential originations and servicing. Much of the carnage in the subprime and alt-A sectors has been blamed on loan brokers aggressively selling mortgages to consumers who could not afford them. It's easy to blame unscrupulous loan brokers, but brokers do not exist in a vacuum. If a table funder isn't willing to originate a product, then a broker can't sell it. And if a Wall Street firm can't originate a loan product (subprime, payment option ARMs, alt-A) then a wholesaler may not offer it. Yes, there were bad actors in the brokerage sector but there is a long "chain of blame" out there.
With loan volumes cratering and a new intense focus on loan quality, the wholesale/broker segment will suffer over the next few years. That's one trend we see. In the fall of 2007 Bank of America (before it announced that it would buy Countrywide) said it would close its wholesale division. A few months after that, National City, and Washington Mutual did the same - as did several lower ranked firms. We anticipate that more large funders will re-assess this channel in the year ahead. Also, Countrywide - which became part of BoA in July 2008 - will still have some type of presence in wholesale. We don't know what that presence will be though. BoA is sharing little at this point.
With wholesale players leaving the channel, that could mean more business for lenders that still believe that wholesaling is the place to be. The loan brokerage movement was sparked by Countrywide in the 1990s. CFC was looking for a way to ramp up production but without incurring the "brick and mortar" costs of retail. (Brokers don't get paid unless they deliver.) CFC had stumbled upon loan brokers in the early 1990s. Many early broker pioneers were actually laid-off loan officers who had worked at savings and loans. (And we all know what happened to the S&L industry.)
There is a fear that the entire broker community might be wiped out in two years. Right now, it feels that way to some. Brokers have taken a lot of heat for the mortgage meltdown, some of it well deserved, but one thing cannot be forgotten: loan brokers do not exist in a vacuum. Yes, they're the salesmen (and saleswomen) peddling the loans but they do not create products and they certainly don't securitize them. It's up to the wholesaler to keep out the dirt bags. If wholesalers and Street firms bothered to conduct real due diligence on the loan brokers that were fronting for them, perhaps, the damage would not have been so bad.
Going forward it will be tougher for brokers, no doubt. Congress is toying with national licensing for brokers, which is a good idea. It's also a good idea for retail loan officers and wholesale account executives. But will it happen? Your best bet for updates on this issue is to read National Mortgage News and its daily website: www.nationalmortgagenews.com.
There are many lessons to be learned from the mortgage debacle of the 2007/2008 so let's list a few: Wall Street can't be trusted (that's obvious); loan brokers aren't boy scouts (okay, we already talked about that); payment option ARMs are dangerous (a given); and my personal favorite: home prices cannot rise by 20% a year forever.
The subprime business as we came to know it over the past eight years is over. We all know that. The only 'subprime' related loans being funded are being sold to Fannie Mae or Freddie Mac, which are now (and rightfully so) tacking on new delivery and guarantee fees to cover the risk they're taking on. The other type of subprime loans being funded are 'hard money' mortgages where the borrower has at least 70% equity in the home and is refinancing because he or she really needs the money.
One of the Baldwin boys (Rick) whose family helped found First Franklin Financial Corp. (before Merrill Lynch took it over and then closed 14 months later) is now running a subprime/hard money shop called Excelsior Fund. "We're doing bridge loans and equity loans," Mr. Baldwin told us. "We prefer not to call it 'hard money.'"
In other words, we're going back to the days of the 1960s and '70s when subprime was a much smaller niche business and the originators are either keeping the loans themselves or partnering with an investor - like a doctor, dentist, lawyer or hedge fund. If you think Wall Street is waiting to jump right back into subprime then I have some Enron bonds I'd like to sell you.
But I'm getting off track a bit. I was talking about lessons learned. There's been a ton of excuse making over the past year. Here's my favorite, which I will paraphrase: the president of the United States wanted us to increase the home ownership rate and to do so we created 'affordability products.' Calling a loan an affordability product is like referring to napalm as ant spray. (POAs give consumers four different payment choices each month including negative amortization where they can keep their monthly payments artificially low by adding on to the debt owed.)
This leads to my next point - what came first: the chicken or the egg? Escalating home prices or the payment option ARM? After covering POAs for several years - I've written about them in this book before - I've come to the conclusion that these loans were one of many reasons why home prices rose so rapidly in once hot markets. The home buyer was told by the Realtor or loan broker (or both): "You can buy more house because your payments will be lower." It empowered home buyers to bid up prices.
Maybe it's obvious but I think it needs to be stated that POAs, 80/20s, no down payment loans and stated-income mortgages all allowed people who should not have received mortgages to get one. By having so many buyers armed with mortgages it was inevitable that home prices would go up - especially in the most desirable markets. What came first - escalating home prices or the POA? Answer: POAs. Without these and other 'non-prime' (not necessarily subprime) mortgages, none of this would have happened.
But it did happen which leads to my next point: why, as a public policy issue, should we encourage Americans who aren't financially ready, to own a home? I know the argument: if you own your own home you're less likely to burn down the neighborhood. Yeah, I get it. I remember what happened in the South Bronx back in the 1970s too.
I will argue this - that home ownership is something that Americans and immigrants living here should earn. It's not their God given right. If they want to own a home, they should scrimp and save just like my wife and I did and just like our parents did before us. That means giving up the big screen TVs, the trips to Vegas, the double lattes at Starbucks, the $10 lunches, and all the other junk people buy that they don't really need. (Do we really need I-phones?) Visit the deli section and buy cold cuts for lunch. You'll save $50 a month right there.
We need to go back to a mortgage system where down payments are the norm - not the exception and we don't need a bunch of loan brokers, Realtors, elected officials and Wall Street experts telling us otherwise. I say: 3% minimum for all down payments, FHA or otherwise. If a couple can't come up with 3% then they should do what 32% of the population does: rent. There's an added bonus to renting: if the toilet breaks it's the landlord's problem, not yours.
Let's restate the obvious: Over the next two years that can be sold to Fannie Mae, Freddie Mac or insured by the Federal Housing Administration will be the hottest products in the industry. During this time the focus will be on credit quality, underwriting and appraisals.
As this book went to press, we were approaching the one-year anniversary of Bear Stearns' decision to throw its two subprime hedge funds into bankruptcy, a move that cost investors about $20 billion. A few weeks after that Countrywide co-founder and CEO Angelo Mozilo, during an earnings conference call, likened U.S. housing market conditions to that of the Great Depression.
As this book went to press, we were approaching the one-year anniversary of Bear Stearns' decision to throw its two subprime hedge funds into bankruptcy, a move that cost investors about $20 billion. A few weeks after that Countrywide co-founder and CEO Angelo Mozilo, during an earnings conference call, likened U.S. housing market conditions to that of the Great Depression.
Twelve months have passed since the mortgage industry began its freefall, taking along with it the housing market, the non-prime lending industry, construction jobs, Wall Street jobs, mortgages jobs and anything related to housing finance. The only bright spot for the industry is the servicing side of the business and foreclosures (that is, if you make money off of foreclosures). It's not a nice picture. And the chief question many are asking (those who still have jobs) is this: when will the industry recover?
Coming up with answers isn't easy. Currently, there is a 12-month supply of new and existing homes for sale (give or take a month or two). Consumers are feeling anxious. White and blue collar jobs are disappearing. The domestic auto industry is shedding workers because their reliance on the SUV market turned out to be a Trojan horse: car makers got hooked on the fat profit margins of larger vehicles without paying attention to warnings that cheap gasoline would not last forever.
Banks, S&Ls, mortgage companies and investment bankers are all cutting workers because the loan market is in the doldrums and writedowns on mortgages assets (subprime and other wise) are not over, at least not yet. We're at $300 billion in "hits" and counting. All things being equal, contrarians (of which I'm one) might say, this could be a good time to actually enter the mortgage business. But there's an economic problem that continues to plague not only housing/mortgages but the overall economy: rising oil prices. As I write this column oil is coming off a week in which it entered the nosebleed territory: $140 a barrel with investment bankers and others predicting $150 within a few weeks.
High oil prices make consumers feel bad and for good reason: the more they pay at the pump, the less they have to spend on everything: clothing, food, entertainment, going out to eat, utilities, savings, take your pick. The less consumers save, the less money that will be available for a down payment. Some first-time home buyers might look around, thinking the market has bottomed, but when gasoline hits $4.50 a gallon they might reason: "Might as well wait. Home prices could drop even further and I might not have a job." Who can blame them for thinking like this?
I'm not going to pretend I have answers to the nation's oil crisis, but I'll argue this: if oil were at $80 a barrel, the housing market might be finding a 'floor' after 18 months of declining home prices. Instead, oil is reaching for a new ceiling - weekly, which means the housing floor keeps sinking. In the U.S. we ship a majority of our goods by trucks which run on gasoline. (When's the last time you read a news story about a transportation company working on a new rail line?)
When oil prices rise as rapidly as they have something has to give. Consumers need gasoline to drive to work. When they cut back it will be on unessentials. But cut back, they will. And when consumers stop spending businesses start hurting and when businesses start hurting they begin laying off workers and when workers get laid off they stop paying their mortgages. It's a bit like that children's book, "If You Give a Mouse a Cookie." The moral of the story? Answer: one economic event (high oil prices) leads to a whole new set of woes, setting off an economic chain reaction.
If the oil crisis can be solved, it will help the housing and mortgage industries (and every business tied to them) recover. We keep hearing that oil is so expensive because India and China keep gobbling it up as though they were Americans (how dare they!) Oil is also going sky high because the dollar is weak and speculators are buying up future contracts because it's the only investment game in town.
Some economists keep telling us oil could be a bubble waiting to happen - just like Internet stocks and housing. Maybe so, but in the interim consumers worldwide are paying more, creating huge amounts of wealth for oil producers, especially those in the Middle East who seem none-too-willing to increase production. But they have done us at least one favor: some have bailed out our financial institutions by investing in preferred stock and taking a price of the action, which leads me to ask: is this any way to run a country? Or an industry?
Thanks to refinancings, residential lenders funded $525 billion worth of loans in the first quarter, a slight increase from the previous period but a 30% decline from the same quarter a year ago. Subprime production was almost non-existent, down a stunning 95%.
Based on the current run rate, 2008 is shaping up to be the industry's worst year since 2001 when just over $2 trillion in mortgages were written. According to exclusive survey figures compiled by National Mortgage News and the Quarterly Data Report, 63% of all loans funded in the first quarter were refinancings, the highest refi volume in more than four years. Fears about the overall economy, sky-high oil prices, declining home values and rising delinquencies hammered the purchase money business. Meanwhile, NMN and the QDR found that 78% of all loans originated in the quarter carried fixed rates. In the year-ago period, 62% of all loans funded were FRMs.
In the decimated subprime sector, which is a shadow of its former self, mortgage bankers originated just $4.1 billion in loans, a stunning 95% decline from the first quarter of 2007. Just 18 firms reported subprime originations compared to 50 a year ago. Wall Street has stopped securitizing subprime loans and the business (what's left of it) has gravitated toward 'hard money' firms that will only fund loans where the consumer has significant equity in the deal. Even though all residential volumes are clearly on the decline, the nation's top five lenders, as a group, picked up market share: 56.89% in the first quarter, compared to 44.2% for all of 2006. But the nationšs top originator, Countrywide, saw its market share slip: 13.9% vs. 16.52% in the year-ago period. Its production fell 36% to $73 billion. (See exclusive rankings in this edition.) CFC, as we noted, is now owned by Bank of America. Counted as one, the two firms funded $111 billion in home mortgages with a market share of 21.21%, which would be the highest share ever recorded in the industry.
Wells Fargo Home Mortgage, San Francisco, ranked second with $65.9 billion in originations, a 3% decline from the year ago, followed by Chase ($54.3 billion/up 10%), CitiMortgage, O'Fallon, Mo. ($40.8 billion/down 25%), and BoA ($38.3 billion/down 15%). The nation's top 25 lenders originated $442.7 billion, a 20% decline from the first quarter of last year. The top 25 control 84% of the production market while the top 100 control 90%.
The mortgage industry is all about interest rates, isn't it? When interest rates are at historic (or near historic lows) refinancings spike, home sales increase and the mortgage industry rakes in the dough. Low unemployment is a key ingredient as well. If consumers are gainfully employed they'll buy homes. If the middle - and upper middle - class feels like taking a roll with the dice they may scrape together enough money to buy a second home, especially in vacation markets where they can rent out the property to help pay the mortgage.
Mortgage bankers also perform best when there is a wide spread between short- and long-term interest rates. The real estate finance business is all about math: borrow money (for example) at 3% and lend it out at 6%. What's left is your profit minus the operating costs. It sounds simple but it's not. The spike in oil prices changed everything. The consumer - even if he has a job- feels poor. When it costs $100 to fill up your SUV what's there to feel good about?
For a while it looked as though the good times would last forever. For non-depositories, warehouse credit was cheap, and loan brokers (not surprisingly) seemed to have a never ending flow of steady customers. Unfortunately, we now know (in retrospect) that many subprime (non-prime) consumers who obtained credit probably shouldn't have. By mid-2008 the writing was on the wall: foreclosures were rising to new highs. The mortgage industry was going through a wrenching realignment. Countrywide - the former king of mortgage banking - was no more.
Delinquencies will continue to be a problem throughout 2009. In the meantime, some lenders/servicers will step up to the plate, picking their opportunities amid the rubble. Enter only the brave.
- Paul Muolo, editor & publisher, MID (Paul.Muolo@SourceMedia.com)
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