Low rates and high profits breed optimism

Last month mortgage bankers and much of the nation were pretty steamed at Congress and the White House for fiddling around on a budget ceiling deal.

Paul Muolo
Paul Muolo

As Washington burned gold prices soared, the stock market began to falter and many consumers held off on buying big-ticket items including homes and refinancing their existing abodes.

In the end cooler heads reached a compromise and then ratings agency giant Standard & Poor’s downgraded our nation’s credit grade a notch. So long AAA.

In theory, when your credit rating gets dinged you have to pay more to your lenders to borrow because you’re more of a credit risk. Right? Not really. Not when you’re Uncle Sam.

Because the rest of the developed world is in such horrible shape with financial obligations and debt loads, investors worldwide still believe the US is a safe haven.

This means that now more than ever, investors are willing to snap up our Treasury bonds like carnivores at a slaughter house. And when bond demand rises dramatically, rates fall.

Now investors are willing to snap up our Treasury bonds like carnivores at a slaughter house

Boy, have they fallen. At the time of going to press a savvy mortgage applicant with good credit can get a 30-year fixed rate loan with no points paid upfront at just 4%. In the US mortgage market points are a form of pre-paid interest, with one point roughly equating to 1% of the loan amount.

If you’re willing to pay a point or more you can buy down the rate and get a loan in the mid-3% range a 30-year fixed rate that never changes.

As Bill Dallas, a veteran mortgage banker from Southern California put it to me, the fact that the 10-year US Treasury bond is at 2.1% is unbelievable.

Most mortgages track the 10-year bond, so you can see where this is leading mortgage applications are on the rise.

Fannie Mae, the mortgage giant that buys loans from lenders in the primary market, has already increased its origination estimate for Q3 to just over $300bn a 27% jump from a forecast made six weeks ago. For the full year Fannie is anticipating $1.1trillion.

But mortgage banking, like everything else in the world, is relative.

Last year lenders funded $1.6trillion, so that means even with God’s gift of lower rates, volumes will drop by 31%.

Still, the economic carnage of the past three years has bestowed a gift on our surviving mortgage bankers profit margins are wonderful especially for deposit banks that are funding 4% to 5% originations with deposits that cost them less than 1%.

Obviously, lenders have seen better days when it comes to loan volumes. In 2003 lenders originated a record $3.7trillion in loans and that was before sub-prime lending exploded. And one other obvious point 70% of most new applications are for refinancings.

The home purchase market is still in the tank, with not much hope for a revival until late 2012. High unemployment here and declining home values are key deterrents.

But it can’t rain forever. There is growing hope in the industry that housing and mortgages will revive and that firms with strong management, capital and know-how will continue to thrive even when the profit margin equation changes.

There also is evidence that some US mega-lenders such as Bank of America, Wells Fargo and JPMorgan Chase are growing tired of all the loan losses they’ve racked up from the go-go years, and will either scale back significantly or get out entirely.

But some of that may just be optimism on the part of up and coming firms that want to gain market share.

Certainly, Wells Fargo, the US’ largest home lender, is committed to mortgages even though in the spring it laid off thousands of workers who process loans because of declining applications. Bank of America also had major layoffs, JPMorgan Chase not so much.

When it comes to mortgages, if any bank is on the ropes it is Bank of America. Its 2008 purchase of Countrywide Financial Corp, which as deals go is pretty much the poster child of what went wrong in non-prime lending, cost it upwards of $30bn in losses and counting.

The North Carolina-based bank recently made a strategic decision to sell some of its $2trillion of mortgage processing rights, so when it comes to the servicing side of the business receivables it could be half the size within three years.

With a market share of 20%, that’s a lot of loans for someone else to pick up. Hence, the optimism of smaller players gaining from the misfortune of one giant.