The Coming Contraction in Mortgage Lending

In my conversations with lenders, I have been reminded of one truth about this great industry where I made my career: we tend to be very short-sighted.

My caution is that while recession concerns have helped drive bond rates to new lows, and with the understanding they could go lower, there will be an end to this run. And once the floor is found, the industry will be significantly oversupplied.

Honestly, there are very few who have not been on the receiving end of this almost uninterrupted run of declining rates that began following the peak in the early 1980s.

While there have been upticks along the way, we have built a massive industry where refinance activity became a key driver to bloating the capacity it can provide. So, here is my warning to our industry about what will likely happen. My only question is, when?

Little Room Left: I often hear sarcastic responses when I warn of the contraction ahead. But math is math. In order to have a refinance market, there has to be room for lower rates. If you look at where rates stand today, there is little room left. Even if rates level and bump around the current range, refinance-able loans will burn out. The graph above says it all.

GSE ‘Reform”: The long-awaited administration GSE paper is expected to be released soon after Labor Day. Regardless of how it approaches the questions about legislation versus administrative reform, there is an expectation that the FHFA will administratively take steps that will affect the footprint of the GSEs. Whether increased capital costs (which will translate into higher mortgage rates) or explicit policy changes (that may restrict certain types of transactions that are deemed to be out of scope), it seems likely that a more conservative outlook will, at best, marginally reduce the options to originate loans to the GSEs competitively.

QM: The CFPB has announced they will end the QM patch. But some have suggested the GSEs might just continue what they are doing, regardless of the rule changes. Whatever happens, I find it unlikely that investors and lenders will take on the assignee liability of moving some of the loan volume from Safe Harbor to Rebuttable Presumption. Whether requiring separate pooling or simply higher pricing to offset the risks, the end of the patch creates uncertainty and real challenges in making up the gap. The MBA has proposed a workable solution, but it is rare for regulators to adopt policy recommendations from trade groups in full.

Recession: It is highly likely that we are headed to recession. The cost burden on servicing with advances and personnel expense, combined with other operational costs for any marginal increases in defaults, will come on top of these other market and policy conditions that lay before us.

In watching market corrections over past years, I often find lenders in trouble trying to sell at the worst time based on some EBITDA multiple from previous boom years. These transactions often end up as a purchase for cash on hand, and an earn out, as smart acquisition experts know not to pay forward for past performance when conditions shift. Frankly, for some, it may be best to look at monetizing at the peak.

For others with the capital and liquidity commitment and access to a dependable balance sheet, as I wrote in a recent HousingWire piece, servicing may be one consideration for forward looking plans to weather the final slowdown. There are risks involved and I encourage any lender looking at this option to read my analysis on the subject and consult an expert.

Bottom Line: A great friend in the industry who ran an IMB out of Birmingham once told me that the key to success was to make hay while the sun shines, and save enough to survive the downturns. Sage advice for sure, but this environment is different today. The industry has grown so large in size with more aggressive competition that, given the less likely refinance opportunity after this last gasp, it will be the best business models who focus on purchase transactions that survive long term. Discipline and forward thinking will be critical at a time like this. Let’s not get consumed with this temporary reprieve.

 

By David Stevens

David H. Stevens, CMB, is former SVP of Single Family at Freddie Mac, former EVP at Wells Fargo Home Mortgage, former President and COO of the Long and Foster Realty Companies, former Assistant Secretary of Housing and FHA Commissioner, former CEO of the Mortgage Bankers Association