Challenging Days for Lenders

MBA chief economist Mike Fratantoni looks at some of the challenges facing the industry as the downturn continues, as well as some encouraging news

There was a common theme to just about every conversation at the MBA’s recent conference in San Francisco, says MBA chief economist Mike Fratantoni: “Even though the economy is really pretty good, the mortgage lending business is tough.”

Tough in terms of competition, in profitability, in home price growth outpacing buyers’ incomes, in political and policy uncertainty in the US and abroad, in seriously high debt to income (DTI) ratios among new buyers. The good news, though, is that the industry isn’t getting caught flat-footed: There’s consensus throughout the industry that, for instance, risk sharing is important, or that the level of defects needs to be kept down, Fratantoni noted. Also good news: The waves of new home buyers just coming into the market will drive housing demand and thus push purchase volume back up for at least the next five years — “and it’s just gonna be a phenomenal source of growth.”

Fratantoni spoke with Mortgage Media’s SA Ibrahim during the MBA’s Independent Mortgage Bankers Conference last month in San Francisco. A theme of their wide-ranging discussion was how the industry copes with the ongoing down cycle. Following are the high points of their discussion:


Low interest rates are helping move the market from refi-driven to purchase-driven — which is both harder and more expensive for lenders.

“From 2009 through 2016, honestly it felt like one long, sustained re-fi boom,” Fratantoni said. “… So now we get to the point where an enormous chunk — call it 80 percent — of homeowners with a mortgage have a rate below 4 percent. Now, we didn’t get rates below 5 percent (but for a blip in 2003) until post-crisis. So we have moved a huge chunk of homeowners into a very low rate.” Which makes purchasing more attractive than refinancing for buyers: 2016 saw a 50/50 split between re-fi and purchase; the next year saw purchase at two-thirds to refi’s one-third. Fratantoni figures 2018 and 2019 are going to end up around 75 percent purchase, 25 percent re-fi.

“You know from your lender days, what a difference that makes when it’s in-bound call volume with somebody that is an existing customer, versus outbound trying to reach through your realtor and builder relationships to get that first-time buyer,” he remarked to Ibrahim. “It’s a different business, it’s more expensive in this regulatory environment, the compliance responsibilities that are still immense.” The cost to originate a mortgage has more than doubled, from $4,000 to more than $8,000, he noted — and the drop in volume has meant a corresponding drop in revenue. The market has gone from $2 trillion in 2016 to $1.7 trillion in 2017 to $1.6 trillion in 2018 — though Fratantoni says it’s likely hit close to the low point this year and then start inching up.

As the fall-out rate is greater with purchase loans than re-fi loans — which is dangerous for lenders what with the high cost of processing, Ibrahim noted — will there be a shrinkage in the lenders?

Certainly, says Fratantoni: Just look at profitability stats. From 2008 to 2016, average profitability was around 60 basis points. In 2018, it was down to 20. And of course, in a purchase-driven market, that’s seasonal; you get the higher basis point margins in the middle quarters of the year, the warm months, and lower ones in the first and fourth. It actually turned negative in the first quarter of 2018 — and “I wouldn’t be shocked if it did it again.”

Mortgage rates are at a good place for buyers looking for an entry-level home; demographics are great with 1.5 million new households formed per year; the unemployment rate is near a 50-year low. All good news, with housing demand and home ownership rates going up — but there’s still too many lenders for comfort, some 6,000 in 2017 according to HMDA data. “A lot of those are small community banks doing a loan or two, right? But still, that is a lot of people fighting over a smaller number of loans.”


Another issue of note: The disconnect between home price growth and income growth on a national level, a disconnect particularly pronounced in certain areas of the country. The past couple years have seen home price growth at above 6 percent while wages were growing less than 3 percent, Fratantoni said — and West Coast markets were seeing even steeper home-price grown, some 9-10 percent a year, even more on the upper end.

“I grew up as a credit analyst at Fannie; that’s not gonna be sustainable very long,” he said. “You just can’t do that, you need home prices and income to be aligned. … We said a year or two ago, at some point you’re gonna run into a wall where you run out of buyers who can afford those price levels. … Again, that entry-level demand is so strong from that millennial cohort hitting peak first-time buyer years, I think there’s endless demand for entry-level properties, there’s just not a lot of units available.”

This situation seems to be starting to correct itself, he noted: Numbers he saw that morning saw home price growth dropping down to 5 percent, and he anticipated seeing it at 3.5 to 4 before long. “That’s a healthier market; that’s sustainable for the longer term.”

While shallow slow-downs can be beneficial in a way — Ibrahim called them “the pause that refreshes,” letting air out of an overinflated balloon — there have been some permanent changes that have occurred and will have an impact. Notably, the $10,000 cap on deduction of real estate taxes and state income tax, and the mortgage interest deduction cap dropping from $1 million to $750,000. Parts of the New York and New Jersey market may be negatively impacted, Fratantoni said, though we’re not seeing the impact yet. There is an offset — a lot of those households weren’t deducting state and local anyway, as they were paying the alternative minimum tax.

“What we’ve seen historically in the U.S., I think, is consistent with what we’re seeing here, where you’d have a period where home prices run ahead of incomes, become unaffordable; transaction volume plummets,” Fratantoni said. “It’s not that prices drop sharply, but transaction volume does fall, because buyers are saying, ‘I’m not gonna pay that.’ Sellers get too aggressive in terms of their asking prices. We’re in that adjustment period right now.” Sellers are thinking more of 2 or 3 percent gains than something like 30 percent.

As for incomes, the fastest growth in wages is in the bottom half of the income distribution, which hasn’t happened in a long time, Fratantoni said. That’s partly a function of the 50-year lows for unemployment, he noted: “We are pulling people into the workforce that haven’t worked for a long time” — including disabled people finding jobs in a remarkably strong job market.

The economy may still be performing, and unemployment may be at a generational low — but there are still plenty of wild cards that drive investor uncertainty. What will the Fed do — will it hike rates? What will be the implications of Brexit, or of China’s sharp slowdown, on the global economy? For that matter, what impact does the rollicking U.S. political scene and corresponding uncertainty have? (“Just look at the shutdown: We just don’t seem to be able to make decisions the way we did even 10 years ago, right, at the US federal government level,” Fratantoni said.)

Stock market volatility in December was historic, he noted — particularly for a time when the economy is doing well.

“And it really was just investors, both U.S. and globally, just expressing uncertainty of ‘We don’t know where this thing is headed next. We know there’s gonna be a slowdown, but how bumpy is this landing gonna be?’”


So have consumer balance sheets strengthened since the last downturn? Are we in better shape to deal with a slowdown without seeing a negative spike in credit performance?

The answer’s a mixed bag, Fratantoni noted.

“So there’s two stories going on,” he said. “If you look at the aggregate numbers for a household’s liabilities, relative to their income, it’s extremely low. It looks fantastic, right? And that’s a consequence of that seven-year long re-fi wave going from average mortgage rate on an outstanding loan of five and half down to about four. Right? That’s incredibly beneficial, and the payoff is gonna be for a long period of time. That liability structure has permanently changed. So that’s what the aggregate picture looks like.

“But if you look at that marginal buyer, that next millennial buyer who’s coming into the market, debt to income ratios are going through the roof,” he said.  More than half of FHA’s loans have a DTI ratio above 43 percent, the cutoff for QM — and a significant number are above 50 percent. If people are paying half their income toward housing and other debts, “there’s not much cushion there.”

And without much of a cushion, a catastrophe can be, well, catastrophic. That’s what happened with some of the borrowers in hurricane-hit areas like Houston and Florida, Fratantoni said: According to servicers, they had come in with very low down payments (and in some cases still needing assistance),  high DTI ratios, almost no reserves — so “it didn’t take much to knock them off their feet. And it takes a lot more to recover. So that incremental buyer is a higher credit risk with respect to debt-to-income ratio and LTV.”


Among encouraging news for Fratantoni and Ibrahim: a greater distribution of risk in the secondary market, a move that, Fratantoni said, MBA has been advocating for years. The GSEs have increasingly moved in that direction, and he hopes to see that continue under new leadership, with whatever ends up happening with GSE reform.

He thinks the risk-sharing message will be preserved — after all, he said, there’s something of a broad consensus among industry consumer groups and other stakeholders: “You need risk sharing, you need a single security — the single security has almost launched now; that will be the middle part of this year. You need the ability for additional competitors to come in — just the threat that there might be another competitor in, it disciplines behavior. So MBA has always been a proponent of that.”

MBA organizes a risk management and quality assurance conference in September, and Fratantoni said there’s been a focus for the past 10 years with everyone — lenders, vendors, GSEs — saying the industry can’t afford the kind of mortgage defect rates seen int he last downturn.

“I think we’ve taken tremendous steps there, both in terms of how the industry manufactures loans — I think defect rates are a shadow of what they used to be. And that is just a tighter focus on operational excellence across the board,” Fratantoni said. The legal framework on a repo warrant is much improved, too, so the lender has a better understanding of what they’re on the hook for, he said. He credits the GSEs, Fannie Mae and Freddie Mac, for helping drive that improvement.

Also encouraging: the demographics, the wave of housing demand as the next wave of millennials and post-millennials reach prime buying age, which should push up purchase volume for at least the next five years, Fratantoni said. The industry needs to be ready for them — and to understand the demographics, and be able to modify practices, some aspects of underwriting, without loosening the quality of the loan. For example: “It means if you have multiple generations in a household, you might need to look at more than two incomes, right? I think the industry is coming around to that kind of an approach.”

“Different, but sound,” Ibrahim emphasized.

“It’s not lowering standards,” Fratantoni said, “but it’s providing flexibilities that make sense.”