Dave Stevens on the "long winter ahead" for mortgage lenders

Is the American dream of becoming a homeowner dead?

It's threatened, there's no doubt about that... It starts with the Fed. They overcorrected during COVID by driving rates, putting too much stimulus in the economy, and now they're overcorrecting on the backside driving rates higher than anybody ever anticipated, and putting the burden squarely on the shoulders of of first-time homebuyers who are struggling to qualify for a mortgage.

The second culprit, unfortunately, is a lack of cohesive policy around creating more affordable housing units. It's not just the Biden administration. The Trump administration didn't focus on it and the Obama administration didn't focus on it. As you look at the country right now, who's responsible for housing policy? If it's transportation, that's Pete Buttigieg. If it's the environment, it's the secretary of energy. They have broad authorities, but when it comes to housing, we've taken apart the value of a cabinet position called the Department of Housing.

Since 2008, the Great Recession, we've moved the regulation of Fannie Mae and Freddie Mac out of HUD and created FHFA. So it's a separate regulator responsible for Fannie Mae Freddie Mac. The Federal Home Loan Banks are independent from the President. We took all the Office of Regulatory Affairs which used to report to me as the Commissioner of FHA and moved it over to this new bureau called the Consumer Financial Protection Bureau.

We've got more federal mortgages being done at the Department of Veterans Affairs and the Department of Agriculture. There is no single authority with no single leader in the Biden cabinet that has a level of clout needed to create a national sense of urgency around resolving [housing-related] problems. The first priority here is leadership and I think what we're facing in this country is a really significant leadership void. The unfortunate impact of this is that it's literally destroying the hopes and aspirations of younger Americans who want to buy a home.

Whose role is it to make housing accessible: is it on states, on the federal government, or a combination of both?

So I think [state programs] are partial solutions, no question about it. There are about 1,000 down payment assistance programs in this country. The problem unfortunately is not all states view housing with the same level of priority. If you own a home, you're going to be far wealthier than those that don't.

The challenge that we face right now is one, I think the Fed is overcorrecting. And I think they made some errors in 2020 by over stimulating the economy and now they're just really pushing affordability out of reach with their actions, but hopefully that's about to end. That will solve part of the problem.

The other problem is we just haven't been building the housing stock needed. What we haven't figured out is how to use federal incentives in partnership with private entities to create a better supply. We did it after World War II. There's a place in Long Island called Levittown where they built thousands of homes for soldiers coming back from the war. It was discriminatory, it was for whites only and blacks couldn't live there, but nevertheless, it proved that we could build entry level homes to house soldiers returning from the war…so this can be done, but it requires a national effort. And it requires for this to be on the President's core agenda and it's not on President Biden's agenda. [There is no one] working for the president who has authority to help drive housing policy and who has the ear of the President.

We've destroyed the role of the housing policy leader by diluting the role of the HUD Secretary. Unfortunately, the only authority the Department of Housing and Urban Development has is over the FHA program, that's basically it, and whatever grant money gets allocated to them through budgeting.

You worked as the FHA commissioner for the Obama administration. From that perspective, do you think what the administration is doing is enough to create pathways to homeownership?

I think we are fortunate with [FHA Commissioner Julia Gordon] because she is one of the more well trained FHA commissioners coming into the job. She has been in housing policy at various think tanks, so she knows the issues … but she has a lot of political barriers that stop her from doing what she would have probably done otherwise. For example, she didn't lower FHA premiums earlier because the Office of Management and Budget wouldn't let her. What we do know is that when she dropped the premium by 30 basis points, it moved a lot of business to the FHA.The Secretary has also spoken openly about trying to increase the volume of manufactured housing.

The problem is that they're relatively helpless right now. They are pretty limited because a lot of their authority has been stripped away. I can argue that Sandra Thompson has just as much authority as HUD's secretary, maybe more so, and that's pathetic, really. Not because Sandra's not a good person, it's pathetic because we decentralized all of the policymaking around housing, which only makes it harder to come up with solutions.

The FHFA will soon be making changes to its credit scoring model from a tri-merge to a bi-merge model. Will this actually help increase access to homeownership?

I applaud [FHFA director Sandra Thompson] because she's trying to look for alternatives that may bring in more eligible homebuyers. They're not all going to work like the LLPA changes she made … but the intent was good, she's trying to find ways for the GSE's to do more good in affordable homeownership.

Credit scoring has been one of the very few monopolies in processing mortgage credit in the country. We have one score, one company and they are the exclusive provider of one of the most critical numbers that are used to tell you whether you're gonna get a mortgage or not. VantageScore, to its credit, has been making the rounds around Washington D.C. for a decade and a half, showing how their model can sweep in more potential homebuyers.

I think right now, everybody is trying to determine what it's going to cost them to have to run two scores. What's the impact and credit deterioration by only doing a bi-merge? I think it's minimal, by the way, but some are going to try to make it a bigger deal.

I am worried about anything that adds cost, but I do think the advantage of bringing a second scoring model is that it creates competition and that's generally good. A lot of lenders will disagree because it's just a pain operationally and it adds cost. All of this is going to have an implementation cost, so they're going to view it as an unnecessary cost, so this is a tough one, but I think the effort to try to expand access is good.

With many home insurance companies pulling out of states like California and Florida because of climate risk, what impact does that have on borrowers? What implied risks are there for lenders and housing agencies?

Global warming is real and insurers are saying we can't take it anymore and so what you're ending up with is increased insurance costs, which weren't anticipated by the lender when they originated the loan. It really increases the debt-to-income ratio after the fact causing a potential increased likelihood of default for some portion of those homeowners because their insurance rates doubled or tripled. Borrowers are forced to use a state provided insurance in some cases and the insurance doesn't cover for loss and that's a challenge for the GSEs and investors.

I think ultimately where this is heading is we're going to need far more risk-based pricing driven by climate risk. In other words, if you want to build that home on the coast of Florida, versus somewhere well better protected inland, you can do that, but if you go to Fannie and Freddie, you're going to pay a far more increased loan on the price adjuster and other fees because of the adverse climate risk.

That's because of the huge toll that's been brought on by either massive fires, or massive floods, and we still have earthquake risk. These are things that are only going to increase as the earth gets warmer. I don't think you can have the same credit standards and pricing standards on a home in a high-risk climate area versus a low risk one. And flood insurance alone isn't going to solve the problem. There's got to be a greater cushion of capital by the institutions that are going to take risks in those high-risk market areas.

There has been talk about Ginnie Mae establishing a permanent liquidity facility. Will that help IMBs? What obstacles stand in the way for Ginnie?

Ginnie has the PTAP program, but the problem is that for the lender to use it, they had to claim that they were actually in default, or illiquid as an institution, and stating that means you're basically putting yourself out of business. Warehouse lenders would cut you off.

I think where Ted Tozer, former Ginnie Mae president, is headed with his recent proposal is 100% on point. Between Ginnie and the Federal Home Loan Bank System, I think we need to look at ways to create more liquidity vehicles that are backed by the federal government that can provide short-term liquidity to banks and nonbanks, although nonbanks would likely be the biggest users.

You can't deny the fact that banks are leaving and have significantly contracted their participation in the mortgage market, particularly in the Ginnie Mae programs, and so, it left it all to the nonbanks that do between 80% to 90% of all the business that is put into Ginnie Mae securities. Because Ginnie securities operate on a scheduled requirement, meaning even if the borrower is in default, you still have to pay the investors until you collapse the pool of loans, which puts a huge liquidity challenge on nonbanks in the event of a credit event. So having a liquidity provision makes sense.

Can [President of the Government National Mortgage Association Alanna McCargo] do it? It could potentially impact the liquidity of Ginnie Mae if there are a lot of advances being made. She would have to consider what those costs would be. I'm sure they're doing the evaluation, or maybe already have for various economic cycles. Then if there was a shortfall, what do you do about that?

Ultimately, this would have to go through approval. Ginnie operates under a different level of approval requirement, but I'm not sure what happens with their authorities here and their ability to provide sort of unlimited liquidity when needed. So these are all things that make this all complicated. I'm guessing some portions [of this plan] would run into a challenge.

Does the mortgage industry in general need to be propped up in some sort of way?

This will be the worst winter that I think almost anybody in our industry will ever experience.

People try to say, 'Oh, isn't it like the Great Recession?' Not really, because in the Great Recession, yes, it was horrible, but then the Fed came in with three rounds of quantitative easing, and they drove rates low. We've had a pretty good decade of lending following 2008 because the Fed intervened and this is just the opposite. This is the Fed, not intervening, driving rates through the roof, and it's crushing mortgage companies and there's no bailout.

There's no doubt that we're gonna see a lot more consolidation over the winter. Many IMBs have done a lot of cuts and they'll do more. Some have a good capital cushion from what they've built up in 2020 and 2021, so they are drawing down on their capital, but they've built up good cushions.Others, frankly, are just not going to make it. Their business model isn't structured in a sustainable way and they don't have the capital cushion to survive. And so for those, we'll see them sail, sell or shut down.

Don't forget, we have a lot of individual loan officers who on their own are going to self-select, they're going to say 'This is too damn hard. I'm gonna go get another kind of employment.' This will be the worst winner that our industry has ever faced. It'll be followed by better years ahead, no question, but this will be [a very tough time.]

How do mortgage lenders survive one of “the worst winters the industry has ever faced”?

It all depends on what their structure is. If you have a servicing portfolio, you could sell some over the winter and bring in some short term liquidity. You could do some more cuts, take your least profitable operations and consolidate them and cut some of the excess. There is still a solid percentage of operational support that could be cut. A lot of lenders have held back from doing that because they thought rates may come down and they wanted to be prepared to be able to handle any increase in production. Unfortunately, I think it's going to be at least April until we see the light at the end of the tunnel, or at least a clear bottom. So let's say March is when the bottom will hit. And so in that context, I think there's more cuts that need to be made. And then there are a lot of lenders right now shopping themselves trying to get sold or taken over.

[Regarding Fairway Independent Mortgage and CrossCountry Mortgage] all I can say is that they're both run by really great leadership and they're very good lending companies. I don't know if they were ever in talks. And when I read the story about it, I would have been surprised to see a merger going on where nine executives, former executives even, would know about it because these are all done under very intense nondisclosure agreements where nobody talks.

I do know that times like this creates bad behavior, there can be rumor mongering and if I had a nickel for every company I've heard is going to go out of business when they're not, I'd be rich and it would just be off of nickels.

Every executive I talk to I say just don't pay attention to it, focus on the people, especially your most important people. And keep the vision on next spring and doing everything to be as successful as possible through the winter.

It's just not a good place to be in our business. There's an integrity that everybody should have to be in our industry and making up stuff isn't one of them.

Can outsourcing play a role in lenders staying lean to survive?

I think there's a lot of outsourcing opportunities that people should begin to consider. Small servicers, if they're not using a subservicer, they should look at that. If they have too large an IT staff, I don't think we're developing a lot of new technologies, you can outsource some expertise as we get through the winter. HR and legal, if you grew your staffs larger during the boom period, you should consider contracting them during the slow. I would be looking at any potential outsourcing opportunity and determining whether I can save basis points or cost by doing so and will there be a sacrifice for the quality of my service. In a lot of cases it doesn't make sense, so a lot of times depending on size and scope and your staffing structure and the activities that you operate in as a company, they may be retail, wholesale, or have their own home built technology. And so all of this stuff comes to the question of looking for every opportunity to shave every basis point out off of your current cost structure to get through this.

But I also tell people I consult with to not cut into the bone of an organization because if you go too far, you'll destroy the competence and commitment of the team that you need to be there when we come out of this. So you have to be really careful when you're making these decisions, not to lose the faith and commitment of your organization as you move forward.

You can see the death spiral happen in our industry. I've been in this industry for four decades since I began originating loans back in 1983. I've been through a lot of cycles, and I've seen a lot of lenders overcorrect at the worst time. That's a challenge because a lot of these IMBs in particular are owned by single individuals and they're sole proprietorships who built these companies and every dollar of capital that they have to erode to keep the company afloat to the winner is a dollar out of their own pocket and it gets personal.

But at the same time if you think about the long term and realize that the Fed's going to be done soon, mortgages will come down into the low sixes or probably fives by the end of next year, we'll see a lot more inventory and there is a path to recovery. We'll have a more right-sized industry, meaning there'll be slightly less competition and there will be better opportunities for margin. But you have to have some blind faith to get there because if you don't, you may make the mistake and cut into bone and risk even worse erosion to your company.

Speaking of looking ahead into the springtime, how do you foresee the situation in the mortgage industry changing for the better? And also, what lessons have been learned from this very tough time in the mortgage industry?

Our industry has as generally a terrible case of short-term memory.

I look at the core fundamentals of the housing market and we have the biggest wave of millennials coming into their first peak homebuying years. It's actually the biggest wave of American population ever in history now coming into their peak home buying years and so the demand for homes is going to be strong for years to come. Some may be priced out because rates won't respond quickly, home prices will remain too high, student debt burdens or other things but there's still pent up demand for homeownership.

The pent up demand both on the buy side and sell side is going to hit us because we have just a really slow resell cycle right now and that will come forward next year. So we'll get an increase in inventory, not huge, but we'll see inventory increase. We'll see homebuilders coming back in far more strongly next year than this year. I believe things will resolve themselves, it will be slow, but we will have better years ahead.

The lesson everybody should learn is when you're only as good as interest rates, you may not be that good of a manager, executive or leader.

In other words, you know rates going to two and a quarter percent driven by the Fed, created a lot of multimillionaires, even billionaires in our industry, but that was shooting ducks in a barrel, you could not miss. If you weren't entirely successful financially, you really were not meant for this business, but if you were, that doesn't necessarily mean that you understood how to work in a hot market because it was just too easy. It's markets like this that build great leaders. It's this tough market that's going to build the greatest leaders of our industry, which we will see come forward over the years to come. It's the ones that survive this that are the ones who are the successful executives, and not the ones who got rich quick and their companies blew up.

Dave Stevens foresees the "worst winter the industry has ever faced"