Good and bad news on mortgage debt

Paul Muolo
Paul Muolo

There are two primary ways to make money in mortgage banking in the US fee income from originating new loans or servicing those loans on a monthly basis. Thanks to the housing bubble and subsequent re-regulation of lending standards, the origination business is in the tank, and that’s putting it mildly.

As noted in previous columns, originations are likely to top out at $1trillion this year, a blood curdling 38% drop from 2010.

As for the business of servicing loans and earning monthly processing fees, profits have been decent except, of course, for the delinquency picture.

The good news is that late payments on all home mortgages are beginning to fall. The bad news is that outstanding mortgage debt in the US also is falling.

The strange thing about all this is that during the pre-crash days of the industry two facts were unmovable – that the average nationwide home price would never fall, and that servicing rights as measured by mortgage debt outstanding would never decline.

The belief in ever increasing home values has obviously been blown apart and now it appears after several quarters that the nation’s servicers, which include our largest banks such as Bank of America, Wells Fargo and JPMorgan Chase, are looking at a never ending decline in mortgage debt which translates into fewer home loans to service.

According to figures compiled by National Mortgage News, the newspaper/website I edit, Americans owed $9.47trillion on their first and second liens at March 31, compared to $10.13trillion at the peak of the market in late 2009 a decline of 6.5%.

Stated differently, the dollar value of mortgage debt servicing rights in the US has fallen in five of the last six quarters, with just one minor increase along the way.

According to housing economists and servicing advisers, the reasons behind the dollar decline are obvious.

Delinquencies and four million foreclosures over the past three years have taken loans off the servicing rolls of mortgage banking firms with servicers of all sizes being affected.

Not enough new loans are being written to replace them despite the lowest mortgage rates in decades.

In the most recent ranking of home servicers, four of the nation’s top five firms experienced a year-over-year decline in their mortgage servicing contracts with one exception: Wells Fargo Home Mortgage, which ranked second overall with $1.8trillion in mortgage servicing rights.

Its annual growth rate was a meagre 1%. And remember that Wells Fargo is the largest funder of them all with a market share of 20%, so that says something.

Many consumers are keeping monthly payments the same, but reducing the number of years

“When will this situation turn around? When we see an increase in the purchase [home] market,” says Jay Brinkmann, chief economist for the Mortgage Bankers Association.

But Brinkmann is quick to point out that Americans continue to engage in not only cash-in. Refinancing is where more money is brought to the closing table, but they’re opting to shorten the term of their loans when they refinance.

“Roughly 23% of all refis now are 15-year loans,” he says. “Many consumers are keeping their monthly payments the same, but are reducing the number of years they’ll be making payments on.”

But perhaps the biggest driver of lower mortgage debt is the lack of cash-out refinances.

According to figures compiled by Freddie Mac, in Q1 2011 consumers drew out just $6bn in cash from their homes via refinances, compared to $84bn at the peak of housing values back in Q2 of 2006.

Because home values are still declining in many markets, it’s unlikely cash-out refinances will take off any time soon, putting additional pressure on MDSR balances.

George Christo, executive vice-president of The Prestwick Mortgage Group, Alexandria, notes consumers are simply deleveraging because they lack confidence in home values.

“Some of this is a confidence thing in the near-term market environment,” he says. “Liquidity has confidence. Debt does not.”

He believes that the trend of less overall housing debt might reverse when two events occur.

“First, when housing values stabilise, which will remove some fear from the real estate market of buyers requiring financing,” he says.

“And second, when the competitive balance between cash buyers and those requiring a mortgage changes, and that may not happen until real estate inventories get back to a customarily healthier level.”