Confounded Interest: Why Housing Continues to Perplex Lenders

Craig Blunden started Provident Financial Holdings' mortgage shop in 1987, and has witnessed a lot of cycles. The "craziest" time, not surprisingly, came in the mid-00s. Real estate in California's Inland Empire was white hot, and lenders willingly tossed fuel on the fire.
"Stated-income loans were big here; option ARMs were big. You had four hairdressers pooling their money to buy a house and flip it," recalls Blunden, now Riverside, Calif.-based Provident's CEO. "We had to participate in those things to compete. If we didn't do it, we would have needed to lock up our doors."
Today, things are much calmer — too calm for Blunden's taste really. After two years of healthy home price increases and activity, the market is stalling. Inventories of for-sale properties have shrunk and affordability — the median price of a house in southern California is around $300,000 — has become an issue.
In its fiscal fourth quarter, ended in June, Provident's originations of single-family mortgages fell to $477 million, down 43% from the year-earlier period. With the home lending business under pressure, Blunden recently redeployed manpower from mortgage originations to commercial real estate, a sector that he says looks promising, but is still weak. "It's been really slow coming out of this recession," Blunden says.
The herky-jerky revival of the housing market is causing headaches and strategic concerns for banks everywhere. Though the residential real estate market is starting to recover in some places, it remains dormant in others and, perhaps most unsettling for bankers, is prone to yo-yo in areas like southern California and Las Vegas, where big jumps in prices and sales volumes have been followed by lulls.
Average prices are up nationally — 9.3% for the year ended in June, according to the S&P/Case-Shiller Index. The National Association of Realtors reports that sales of existing homes jumped 2.6% in June, the third consecutive month of increases. But new home sales, considered vital to the broader economy, fell 4.9% nationally during the first half of the year, according to the Census Bureau.
The Mortgage Bankers Association predicts that total originations will come in right around $1 trillion for the year, which would be the lowest level in two decades and a steep drop from last year's $1.7 trillion.
"The real disappointment this year has been a weaker purchase market than expected," says Mike Frantantoni, the MBA's chief economist. "We're looking at about a 10% decline in purchase volume relative to 2013."
The housing market's struggles are an issue for revenue-starved banks. According to Keefe Bruyette & Woods, more than 30 percent of industry balance sheets — roughly $3.5 trillion — are directly related to the buying and selling of homes. Throw in loans to ancillary commercial business, such as contractors and retailers, and the figure climbs higher.
"The strength of the housing market is a pretty good indicator for what makes banks profitable," says KBW analyst Fred Cannon. In a healthy market, "collateral values are going up, people feel confident and borrow more, and credit quality is usually pretty good."
KBW notes that the stocks of banks in California and Nevada, where home prices have shown stronger appreciation, have higher median valuations than those in the Midwest or Northeast, where house prices have been more stagnant. "When housing suffers, banks usually don't do as well," Cannon says.
At Wells Fargo, the nation's largest housing lender, second-quarter revenues declined to $21.1 billion from $21.4 billion a year earlier; over the same period, revenues from mortgage originations and sales plunged 71%, to $688 million from $2.4 billion. Earnings rose 3%.
"If you exclude mortgage, they're humming on all cylinders," says Scott Siefers, an analyst with Sandler O'Neill & Partners. "There's no question about it. If you had a normal housing market, they'd be flying high."
The story is much the same elsewhere. In the first quarter — admittedly a rough one due to particularly heavy snowfall in the Northeast and Midwest — the industry's mortgage banking fees were down from the year-earlier period by a whopping 53.6%, to $4 billion, according to the Federal Deposit Insurance Corp. Originations, at $235 billion, were the lowest in recent memory.
The second quarter saw originations jump to an estimated $267 billion, according to the MBA, and many banks reported higher mortgage-related revenues. But it's all a pittance relative to recent years, and profits remain under pressure — especially when the escalating cost of regulation is added to the equation.
The typical lender has been losing money on every new loan, due to rate competition, mandated caps on origination fees and, of course, higher compliance costs, says the MBA's Frantantoni. "Even when the revenues are doing fine, the expenses are going through the roof."
The housing market has obviously caused the banking industry a lot of pain. Beyond the hundreds of billions in losses and mountains of regulatory fallout, bank reputations took a huge hit from which they have yet to recover. It seems barely a week goes by without one bank or another reaching a big-money settlement with the Justice Department or some agency related to the subprime crisis.
The frustration among bankers is palpable; there's a sense that housing owes the industry after six years of saga. As Ed Wehmer, CEO of the $19 billion-asset Wintrust Financial in Chicago, says: "Housing got us into this mess. Housing has to get us out of it."
Yet finding a catalyst remains elusive. While many other lending segments, including auto and commercial, are showing impressive gains, the jumpstart that the housing market — and the broader economy — needs has yet to emerge.
"Everyone believed that the recovery would be spurred by housing," says Liz Jordan, a director who specializes in credit and lending for Deloitte & Touche LLP. "Now that things have slowed, we're seeing concern about the implications for a full recovery."
Originations were thrown a lifeline by the Federal Reserve's Quantitative Easing program, which in recent years fueled an unprecedented refinancing boom that kept lenders busy. In 2013, refis accounted for $1.1 trillion, or 66% of all originations, according to the MBA.
Rates jumped near the end of 2013 when the Fed began signaling a reduction in bond purchases, and the refi boom abruptly halted. In the first half of this year, just north of $200 billion of refi originations were expected.
Barring an unforeseen drop in rates to rekindle refis, it's now up to purchase transactions to keep the momentum going, and that's not happening. At a projected $273 billion in the first half of the year, purchase mortgage volume was off about 15% from the same period last year.
"The refi business is where we thought it would be, but the purchase market hasn't been nearly as robust as we expected," says Michael Todaro, senior vice president for residential mortgage at M&T Bank in Buffalo.
M&T originated about $1.8 billion of mortgage loans in the first half, well under half its production in the year-earlier period. "We thought there was some pent-up demand out there, but it hasn't materialized yet," Todaro says.
Most mortgage professionals agree the big overarching hang-up is a shortage of first-time homebuyers. First-timers accounted for 28% of existing home sales in recent quarters, compared with about 50% in normal times, Frantantoni says.
"We just haven't seen the household formation from the millennial generation that everyone is expecting to materialize," says Peter Boomer, executive vice president of production for PNC Mortgage. "A lot of young adults are still living at home or renting."
Franklin Codel, executive vice president of production for Wells Fargo Home Mortgage, says low buyer demand caused by "misinformation" about the difficulties of qualifying for mortgages, is a key culprit. "There's a widespread belief out there that you can't buy a house without a 20% down payment or perfect credit," he says.
But, Codel notes, the Federal Housing Administration, Fannie Mae and Freddie Mac all offer programs for borrowers with less-than-perfect credit scores and down payments of less than 10%, "provided you have full documentation."
It doesn't help that there aren't as many houses to buy. In June, 2.3 million existing homes were on the market, according to NAR, representing about 5.5 months' supply. In 2007, both figures were double that.
In some markets, such as Baltimore, only about three months' supply is available. "In many of our markets, we're just not seeing normal inventories," Modaro says.
Many would-be sellers are reluctant to put their homes on the market, "because they know it will sell extremely quickly and they'll have nowhere to go," Codel says. Others are still trying to make up losses in equity following the housing crash or are reluctant to give up low rates locked in during the recent refi boom. "If you're sitting on a 3.5% rate, you want to hang on to it," Modaro says.
The sluggish housing recovery is forcing some hard decisions by bank managements. In the past year, most banks have announced significant staffing cutbacks. Wells Fargo, with about 16% of the origination market, saw mortgage banking revenue drop 42 %, to $3.2 billion, in the first half of 2014, and has laid off more than 10,000 employees in the past year.
Overall mortgage industry employment has fallen to 279,000 in June, compared to more than 500,000 during the boom times. That is a particularly dramatic change, though flux in staff levels is a familiar reality for mortgage lenders. "You need to keep your fixed costs as low as possible, and then be able to cut your variable costs very quickly when the market moves away from you," Wehmer says.
Smaller banks are wrestling with how much to invest in a business that now requires pricey systems, processes and personnel. While mortgages are certain to remain a foundational product for most banks, the "profitability dynamics" of the business have changed, says Siefers, of Sandler O'Neill.
Margins are tighter, costs are higher and mortgages — once considered the safest loans on the books — now look a little risky. "When you know a loan can get pushed back on you
10 years later if it goes bad, it changes your perspective," Siefers says.
Many lenders, like Provident, have been slashing or redeploying origination staff to control costs. Some have gotten out of the business altogether — or at least tried to. Following the announcement of its $680 million merger with MB Financial, Chicago-based Taylor Capital Group attempted to sell its mortgage unit, but couldn't find any takers.
"You're seeing a lot of banks at a crossroads. They're struggling with low demand, tighter credit and lower profits," says Jordan, of Deloitte & Touche. "They're asking, 'Where does that leave me with this product? Is it something to bet heavy on? Or do I only offer it as a convenience to my valued customers?'"
Lenders with the capital and patience to withstand a slump — and the scale to efficiently manage stiff new compliance costs — figure to have an advantage. "The challenge, especially for the smaller guys, is, 'Do you have enough volume to spread those high fixed costs around?'" Frantantoni says.
Wintrust has acquired four independent mortgage companies over the past three years, all of them challenged by the costs of higher regulation. It is looking for more deals, confident the market will rebound.
"The market is going to consolidate, and strategically, we think being in the mortgage business is a nice long-term play for us," Wehmer says, adding that he expects a "slow-but-steady return to normalcy" fueled by broader economic growth.
The underlying rationale behind Wehmer's bet — that homeownership remains a vital part of the American Dream — is, not surprisingly, shared by most bankers. But the foundations of that belief have been shaken by the crisis and changing economic, demographic and regulatory landscapes.
Younger families that comprise the bulk of first-time buyers are buried in student loan debt. According to the New York Federal Reserve Bank, some 30 million Americans carried $1.08 trillion in student loan debt at the end of 2013, up more than 10 percent last year alone.
And while jobs are once again being created, real disposal per-capita income, at $37,226 in May, is about 1% lower than it was six years earlier, according to the St. Louis Federal Reserve Bank.
The mechanics and rules of lending also are tougher. Everywhere a bank turns nowadays, there's a regulator focused on either the institution's risk profile or preventing borrowers from overextending themselves.
There are no more low-doc/no-doc loans, no negative amortization or interest-only loans being made to questionable borrowers. In fact, pretty much anyone with a FICO score of 600 or lower is out of luck when it comes to securing housing-related credit.
The Consumer Financial Protection Bureau earlier this year introduced its "qualified mortgage" standards, which among other things limits a homeowner's debt to 43% of gross income — a particularly high hurdle for the growing number of self-employed workers, who often have trouble documenting their incomes.
"In a market where total debt-to-income is now a regulatory constraint on being able to get a loan, we're seeing stagnant incomes keeping people from qualifying for a mortgage," Frantantoni says.
FHA-guaranteed loans, intended to help less-qualified borrowers, filled much of the post-subprime vacuum, with originations of 1.1 million loans in 2009, or roughly 44% of the total. But a recent hike in the premiums for required mortgage insurance has squeezed as many as 1 million potential homebuyers out of the market, officials say.
Some fret that we could be witnessing more of a structural shift, with younger families preferring to rent instead of buy. Multifamily construction has exploded in markets like Chicago, where Wintrust's Wehmer worries about a rental bubble.
Since 2006, the U.S. market has added 5.5 million renter households, while losing 1.6 million owner-occupied households, according to the MBA.
Getting those young renters out of their apartments and into houses has become an emphasis. The question is, how does that happen?
Banks, and even government agencies, are working to get more buyers into the pipeline. The CFPB has granted a seven-year exemption from the QM rule to Fannie Mae and Freddie Mac, meaning that any loan accepted by the two government-sponsored enterprises' automated underwriting systems is accepted, even if it exceeds the debt-to-income ratio.
Banks are making so-called "non-QM" loans to good borrowers who don't quite fit in the box. Earlier this year, Wells Fargo reduced the minimum FICO score for applicants to 600 from 640. Those applications aren't approved as often, come with higher rates and usually are held in Wells Fargo's portfolio. "We see quality borrowers in that cell that, when properly underwritten, demonstrate an ability to repay," Codel says.
Wintrust has resurrected an adjustable-rate mortgage that it used to offer before the subprime rage for "good customers with some issues, such as being newly self-employed," Wehmer says. Those loans don't qualify for sale on the secondary market. "We charge a little premium on it and hold it in portfolio, and then eventually shift the customer into a long-term fixed rate loan," Wehmer explains. "We think we can build that into a four- or five-hundred-million-dollar portfolio that will churn quickly over time."
This is the way the banking industry works. Cycles happen, paradigms change and individual players react. They find ways to innovate around the roadblocks placed in front of them, and others copy them. No good idea remains proprietary for long.
Today's market might be maddening for those who pine for a quick housing rebound, but longtime market observers say what we're seeing is about as normal as things have been in over a decade, before the artificial support of subprime lending created a bubble. It's just going to take some time to work through things. Despite the bumps along the way, the general direction will be upwards.
"As the economy improves,the housing market will get better," Provident's Blunden says. For bankers, that day can't come soon enough.

How to get a mortgage right now, even with bad credit

In his interview with HousingWire, Mel Watt, the director of Federal Housing Finance Agency urges the opening of the mortgage credit box to less-than-optimal borrowers.
"We are getting lenders to reduce some of the credit overlays," he said in the exclusive interview.
Furthermore, FICO scores will ignore debts that have been paid off or settled, and a lesser weight will be assigned to medical bill collections, which account for about half of all unpaid collections on consumers’ credit reports.
Nonetheless, the average FICOs have been going down steadily since 2006 and it’s not hard to see why, what with the housing crisis, the financial meltdown and the general recession and record unemployment and underemployment.
So what can those with a FICO that is under 620 do to get a mortgage?
1. Prepare to pay more

People with poor credit can still get a mortgage, but they will pay far more than even those with credit scores on the margin.
Guidelines from the U.S. Department of Housing and Urban Development and the GSEs, Fannie Mae and Freddie Mac, advise waiting at least two years after a short sale, so long as credit after the short sale is good.
Sellers should be advised to do their homework on the mortgage brokers they are working with – shady and dodgy operators are like bottom feeders, looking to prey on those who are more desperate and who aren’t financially savvy, which is how they see people with poor credit.

2. Refinance ASAP

A bad credit mortgage may seem like the borrower is signing away their life on a bad deal, but so long as the borrower maintains their credit after the mortgage is signed, they can be eligible to refinance for a much better deal within two years, and their credit will have improved.
In short, a bad credit mortgage is a short-term solution that gets them in a home. It's important to bear in mind that bad credit needn't follow the borrower longer than necessary.

3. Ask about options

The 30-year mortgage is a popular choice, but maybe not the right one if the borrower's credit is weak. Adjustable rate mortgages are also a possibility, depending on the circumstance, during which time the borrower can work on repairing and maintaining their credit while paying at a lower interest rate than are offered on fixed-rate mortgages.
Many people who had their credit torn up in the recession were not the typical bill skippers. They were hard-working, responsible people whose world was upended through layoffs, downsizing, the loss of contract work, and a dozen other legitimate reasons.

4. Get a co-signer

Many have some other assets, or have family members who are responsible. These people may be willing to co-sign. Federal Housing Administration  rules allow for a co-signer on loans.

Above all, check with HUD, FHA, the FHFA, Fannie Mae and Freddie Mac for information on pathways to homeownership for those who have damaged credit.
It is possible to get a mortgage with bad credit today. Possible, but still challenging.

2.5 million borrowers face imminent payment shock

At least 2.5 million borrowers will face an average increase of $250 per month on their monthly mortgage payment due to the imminent reset in home equity lines of credit over the next three years, according to Black Knight Financial Services’ Mortgage Monitor Report.
However, depending upon borrower behavior between now and the time of the reset, payment increases could change, Kostya Gradushy, Black Knight’s manager of research and analytics, said.
Borrowers whose HELOCs will reset over the next three years are utilizing just under 60% of their available credit. If these borrowers utilize more of their credit, they could face even more payment shock as the monthly increase would rise above the $250.
And the news is not much better for the borrowers whose payments are not likely to reset until 2019. These borrowers are exhibiting even lower utilization ratios — about 40% of their available credit. Once reset, they will likely face an average monthly increase of $200.
"Should their drawing pattern match that of older vintages, we could be looking at a significantly higher risk of ‘payment shock’ for this segment,” Gradushy said.

Freddie Mac: Top 5 most improved housing markets- Despite Weak Market, Still Improving

While the housing recovery remains at a snail’s pace, it is still improving, with the markets that exhibit stronger local economies and favorable demographics on an even faster pace of improvement.
Freddie Mac released the June numbers for the Multi-Indicator Market Index, which showed a weak market, improving only .04% from May to June. However, on a year-over-year basis, the U.S. housing market has improved by 7.67%.
“As we see the economy slowly normalizing we’re starting to see its effects in the housing market as well, albeit very slowly. The good news is the big housing markets, of which some were also the hardest hit, continue to improve,” Freddie Mac Chief Economist Frank Nothaft said.
“For example, from the same time last year, California is up 12% and every market MiMi tracks in the state is improving. Meanwhile, Florida is up nearly 15% and Illinois is up nearly 13% over the past year,”
So here is Freddie’s list of the top 5 most improved metros that are faring better than the rest of the nation. (All charts are from Freddie Mac and compare the metro to the nation; click for larger image)
5. Miami

Miami has steadily improved over the year and ranks 32nd, increasing two spots from last month and increasing 11 spots from one year ago. A lot of Miami’s improvement is due to the 14.35% increase in the current on mortgage indicator over the past three months.
4. Chicago

While Chicago stayed in the 44th spot this month, it has increased three spots from one year ago. A 14.89% increase in the metro’s employment indicator over the past three months is a main driver behind the improvement.
3. San Jose

San Jose’s improvement is largely due to the 4.32% jump in its employment indicator over the past three months, moving up two spots to 16 and up 3 spots from one year ago.
2. Riverside

Although the Riverside market is weak, it is improving, moving up two spots from last month to 24. This is up 16 spots from one year ago. Like the other metros, this is due to the metro’s 11.93% increase in the employment indicator over the past three months.
1. Las Vegas  

Despite being ranked 50 out of the top 50 metros, Las Vegas is 92.8% above its all-time low of 25 reached in November 2010. A lot of the metro’s improvement is due to the 12.54% increase in the employment indicator over the past three months. The city ranks 50th and is unchanged since last year.

Realtor Confidence Falls

The July 2014 Realtor Confidence Index shows that Realtors aren’t enthusiastic about current conditions and the outlook for the next six months.

Concerns about federal regulations burdening the process, the drop in demand for middle and lower-cost homes, and rising affordability problems headlined their concerns.

Realtors reported some uptick in inventory in some areas, but generally, supply remained tight relative to demand in many areas, especially for “lower” and “middle-priced” homes, according to the July survey conducted by the National Association of Realtors.

Distressed sales continued to account for a smaller share of the market.

Realtors continued to report about the restrictive effects of the current credit conditions, especially in relation to the credit score and down payment requirements that will qualify buyers for a mortgage.

The home buying process was reported to be “long and difficult” even for “quality borrowers”.

Although the home price recovery has encouraged more listings, the strong price growth amid modest wage income gains has also made homes less affordable, creating a demand for lower-priced homes that are, unfortunately, in short supply.

 

Changes in the Federal Housing Administration mortgage insurance premium regulations, the cost of obtaining flood insurance, and increases in property taxes were also reported to be having a negative impact on potential sales.

 

FHA financing regulations continued to be reported as severely impeding condominium sales.

 

Confidence about current market conditions declined across all markets in July 2014 compared to June 2014.

 

In the single-family market, the Realtors Confidence Index - Current Conditions for single-family homes dipped to 60 (62 in June), indicating that a smaller percentage of Realtor respondents viewed the market as “strong” compared to a month ago.

 

Overall it's not pretty.

 

Confidence about the outlook for the next six months similarly declined in July compared to June. The six-month Outlook Index for single-family homes fell to 60 (63 in June); the index for townhouses edged down to 45 (46 in June); and the index for condominiums dropped to 40 (41 in June).

 

Tight inventory, difficulties in obtaining mortgages, and weak job growth were the main concerns reported by Realtors.

 

In some areas, the uncertainty about flood insurance rates, and the increase in property taxes were also cited as adversely affecting sales. FHA condominium accreditation/financing regulations continued to adversely impact condominium sales.

 

The Buyer Traffic Index declined in July to 55 (58 in June). Meanwhile, although inventory is improving, supply is still broadly tight: the Seller Traffic Index is still below 50 and essentially stayed flat at 45(44 in June) 3.

 

An index above 50 indicates that more than half of Realtors view traffic conditions as “strong”.

 

Realtors reported some uptick in inventory, but supply remained tight relative to demand in many areas, especially for “lower” and “middle- priced” homes.

 

There were reports that some potential sellers are hesitant to sell because of concerns that they will not find an affordable replacement home with adequate mortgage financing in a tight market.

 

Other potential sellers are waiting for further price increases either to increase the equity gain or to move out of a negative equity position.

 

NAR also tracks foot traffic using Sentrilock, data. Lockboxes made by SentriLock, are used in roughly a third of home showings across the nation.

 

This index rose to 54.8 in July (42.5 in June), which indicates that more than half of the roughly 200 markets tracked in this panel reported an increase in foot traffic in July.

 

Fewer Realtors reported rising prices than was the case in J une, but home prices are still broadly rising. Approximately 65% of Realtor respondents reported that the price of their “average home transaction” is higher today compared to a year ago (68% in June).

 

About 23% reported constant prices, and 12% reported lower prices. Tight inventory has sustained the price growth in many areas.

 

With inventory still generally tight and multibidding prevalent, approximately 14% of reported sales were at a net premium compared to the original listing price. In mid-2013, about 20% of Realtor respondents reported selling properties at a premium. About 70% of properties sold at a discount compared to the listing price, with about half reporting a discount of 0 to 10%.

 

Realtors responding to the survey expect home prices to increase modestly in the next 12 months, with the median expected price increase at 3.4%4. The expected price change is modest compared to the strong price growth in 2012-2013. Local conditions vary, but concerns about how borrowers are finding it difficult to obtain a mortgage and weak job recovery appear to be underpinning the modest price expectation.

 

The map shows the median expected price change in the next 12 months by state of Realtor respondents in the May – July 2014 surveys. Respondents from Florida and Texas were the most upbeat. Tight inventory and the strong growth in Texas metro areas may account for the optimistic outlook. Expected price growth is more modest in other states.

California housing market underperforms in July-Pending home sales drop four months straight

July was not a strong month for the California housing market as the state continued to underperform.
California pending homes sales dropped in July, with the pending home sales index falling 2.3% from 107 in June to 104.5 in July, based on signed contracts, according to the California Association of Realtors. However, the month-to-month drop was consistent with seasonal trends.
This is also down 9.2% from 115.1 in July 2013. “Pending sales have been down year to year since October 2012, but the pace appears to be decelerating as the decrease in July was smaller than the average in the last six months. Pending home sales are forward-looking indicators of future home sales activity, providing information on the future direction of the market,” CAR said.
As noted in the 3 facts crippling California’s housing recovery, the combined share of all distressed property sales continued to decrease in July, dropping from 9.7% in June to 9.4% in July.
On the other side, the share of equity sales — or non-distressed property sales — maintained its upward trend, increasing to 90.6% in July, from 90.3% in June.
Equity sales have steadily increased since the start of the year, making up more than 80% of total sales for more than two years and rising above 90% for the second straight month.
Despite the bad month for the market, next year is projected to be the best year yet for the economy since the start of the recovery, according to a report from Beacon Economics, with California's state economy lining up to do better than the nation.

Foreclosures Up/Delinquencies Down

Foreclosure starts in July were up for the third consecutive month even as the overall inventory continues to decline, according to Black Knight Financial Services.
This is Black Knight’s analysis of the July 2014 month-end mortgage performance statistics derived from its loan-level database representing approximately two-thirds of the overall market.
Overall the news looked good.
Click below to enlarge.

The national foreclosure inventory is down 34% from July 2013. At the current rate, it is now the lowest since March 2008, at the start of the housing crisis.
Despite the increase in foreclosure starts, starts are still down almost 20% from July 2013, which is a significant improvement.
Click the image to enlarge.

Further good news, delinquency rate declines after slight increase in June 2014.
Even more good news, the rate of prepayment is up more than 10 percent in July, making it the fifth consecutive monthly increase.