OCT 2, 2013 10:39am ET

Fourth Quarter Business Depends on the Fed

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Interest rates have retreated downward from their spike in the late spring and summer but the impact of that has “not been overwhelming yet” for mortgage bankers, said the CEO of Freedom Mortgage.

Still, said Stan Middleman, lower rates will prolong the dominance of the refinance business which has been a major source of originations through the fourth quarter.

While lower rates have not rekindled the refi boom, it will allow consumers who have yet to take advantage to be able to do so, he said. Given the Federal Reserve’s implying that it is likely to taper in the not-too-distant future, Middleman said rates could rise before the end of this year.

“Of course all of this is subject to what the Fed does, because the natural cycle has little impact. Most of what happens with interest rates really is Fed dependent,” he explained. “The net effect of that would be that as interest rates rise, before the stay of execution on the tapering, we will still see some significant layoffs.

“Volume is down, even at these (rate) levels relative to this time last year, even relative to 2Q13. I think we will see lower volumes and tighter margins as companies continue to compete,” Middleman said.

Freedom Mortgage has “trimmed back and retooled,” but has not made any massive layoffs at this point, unlike some companies. In the last 12 months it has done $17 billion, but right now it is averaging $1 billion per month. There has been “some retrenchment, but not a vast amount,” he said. But there will be tightening in the industry (including at Freedom) in order to “meet the market.”

Already there has been a lot of margin compression by firms looking to keep their volumes up, Middleman noted. Last year was the best margin year in the history of the industry and some of that euphoria spilled over into the first quarter. But now, margins are far tighter.

Traditionally in the hunt for business, the next move is to loosen underwriting. While things are loosening, it may have less to do with hunt for volume and more with the improvement in property values, he said.

Companies have reduced overlays originally aimed at declining value conditions. We are returning to “a more normalized credit standard,” Middleman said.

Howard Hoyt, president of USA Wholesale Mortgage, sees the fourth-quarter situation for mortgage originators as “being status quo.” However, the big change in the market will take place in January 2014 when new Consumer Financial Product Bureau regulations kick in, on top of the likely Fed taper.

There is a lot of misinformation in the marketplace, and Hoyt said the CFPB has not made things crystal clear. A lot of his competitors and his clients “have chosen to stay the course,” for now.

He does see some consolidation as a result of the new rules, creating larger entities to help share the costs of compliance and to get a competitive advantage in 2014.

“We’ve purged our piece of the industry quite a bit,” Hoyt said, with those left being the “smart cookies” who are able to figure the new reality out. Thus the future for originators is bright.

The third-party channel gives consumers a lower-cost alternative to get a loan. Lenders don’t have to provide brick and mortar or training; it is on the shoulders of the broker.

So there is an advantage for having the third-party originator survive, Hoyt said.

David Zugheri, executive vice president at Envoy Mortgage, agreed with Middleman, declaring that the rate drop after the no taper announcement is good for the mortgage business in the near term.

Application volume has been higher, as seen in several recent Mortgage Banker Association reports, and that has been largely due to growth in refinance activity.

But “refinances are kind of a cheap trick if you are a mortgage company,” Zugheri said. Those mortgage companies that have been in the business for the long haul know that purchase business is important for survival and their ability to prosper.

Still, “a lot of us are ready for the free markets to take back over. And if that means that interest rates will go up, then interest rates will go up and we will have to adjust,” he declared.

From a business perspective Envoy tries to control the things it has control over, but interest rates are not one of them, he said. The company has not lain off people because of a reduction in volume, but it has allowed attrition to reduce head count.

Envoy, Zugheri continued, has been open for 16 years and this is not the first interest rate cycle it is going through.

The first thing that happens in the down side of a cycle is that margins compress. Companies “fall in love” with the volume during the boom time. So there is some pricing pressures, but it is not a surprise for anyone who has been in the business for a substantial period, he said.

Fast forward six months or so, and there might be a company or two that has to close its doors. It is part of the business, Zugheri said.

The lower rates are creating a “temporary stay” of the transition to the purchase market, but it is too soon to know if “we are entering into a phase of industry contraction,” he said.

Zugheri added that in the new market, lenders will compete on two things only: service and price. Credit will not be a part of the equation; he is not seeing investors lower their underwriting standards.

People will have to get aggressive on rates and service. But no one will be able to say they are loosening their guidelines to attract more business and bolster their profits, he declared.

In the 1998 and 2003 contractions, credit quality was compromised, Zugheri said. It is not happening this time around. “You can’t play that card. It is not in the deck,” he added.

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