Then again, it’s nothing I and other industry veterans haven’t seen before. Every four to five years the mortgage market here typically goes through a correction.
Without fail, there’s a pattern to the US mortgage cycle. It starts with a decent year in which residential loan production begins to pick up and then swells over a period of two to three years. The cycle usually ends when interest rates spike northward or unemployment swells, or some combination of the two.
This time around it’s a little different. In 2006 residential loan production hit $3trillion, a modest 7% decline from 2005 – a year in which funders produced $3.29trillion, the industry second best year ever.
The outlook for 2007 isn’t particularly bright, nor is it entirely ugly. At $2.5trillion – which is the consensus of estimates made by Fannie Mae, Freddie Mac and trade group officials – that would represent a 16% decline from last year.
A 16% fall in production isn’t awful but it’s not really a volume issue, it’s a competition issue.
Mortgage rates haven’t spiked and unemployment is still under 5%. Mortgage lenders make a ton of money when there is a steep yield curve.
However, over the past 18 months the difference between short and long-term rates (the yield curve) has flattened which means a lender’s cost of funds equals what it can charge for mortgages.
That leaves lenders in zero profitability mode. Banks and thrifts that use deposits are at a slight advantage because they can balance sheet mortgage assets and aren’t beholden to financiers on Wall Street.
Usually, what happens is that one lender hikes the rate it charges for mortgages and the rest follow like lemmings. This widens the difference between the cost of funds and the mortgage rate charged to consumers, allowing for at least a slight profit.
In this cycle, lenders have barely increased their rates. With home sales declining mortgage bankers are struggling to maintain volume at the cost of profits, a strategy that usually ends in serious trouble. So here we are in the midst of a mini-train wreck in the US mortgage industry.
Just how bad are things? Like I said, it’s not terrible, but there are other factors to consider. Sub-prime lenders that sell their loans into the secondary market (Wall Street) are getting swamped by buy-back requests.
A buy-back occurs when a loan goes south in the first 60 days and the primary funder is obliged to repurchase the delinquent note.
Over the past six months buy-back requests have totalled billions of dollars. Lenders such as Ownit Mortgage Solutions of California that cannot afford to repurchase their bad loans have been forced to close their doors.
Others, including Mortgage Len-ders Network of Connecticut and Secured Funding of Southern California, have slashed their wholesale networks to zero.
In December and January at least 10 small to medium-sized mortgage bankers – mostly in the sub-prime space – have closed their doors. Most were funded by traditional Wall Street firms like Bear Stearns and Merrill Lynch. All were non-depositories.
Meanwhile, the merger and acquisitions market is boiling over. While some firms are failing, others are heading for the exits via sales.
Most recently, Citigroup agreed to buy the residential loan division of Dutch bank ABN Amro. Based in Michigan, ABN Amro Mortgage is the nation’s eighth largest servicer with $224bn in receivables.
Also, British bank Barclays signed a deal to buy EquiFirst Corporation, a top 20 ranked sub-prime funder. This is Barclays’ second major acquisition in three months – in November it bought specialist servicer HomEq.
About five other sub-prime units are on the auction block including Option One Mortgage (ranked sixth in sub-prime production), Ameriquest Mortgage (ranked 12th), Fieldstone Mortgage (24th) and Encore Credit (25th). Those are just the ones I know of.
If lenders continue to fail while others are gobbled up there might be just 20 major mortgage firms left by the end of the year.
Of course, that’s an exaggeration but it certainly feels that way. US mortgage executives rank third among the world’s loudest complainers, behind commercial bankers and lawyers.
Suffice to say it doesn’t feel good right now in US mortgageland. House prices continue to fall and the Federal Reserve will not offer relief on short-term rates until Q4.
In the interim, lenders will continue to fund loans to a shrinking customer base in the hope that a new and better cycle will be born sometime soon. But how soon?
Answer – not until a few more buckets of blood are spilled. As Dan Perl, a mortgage veteran based in Southern California, puts it: “If you don’t have liquidity, you’re gone.”
Paul Muolo is executive editor of National Mortgage News