Talk from the Trenches: Loan Pricing Margins Getting Crushed as Rally Persists; "Bad Loan Biz" Doing Well; FHA Steamline Product; Buybacks and Credit Overlays
A statistician is someone who is good with numbers but lacks the personality to be an accountant.
What's wrong with this picture: Rates are unbelievable, yet there are many companies out there who are barely writing any loans. Investors are backlogged and swamped, yet mortgage banking employment numbers are down significantly from only a year or two ago.
In many markets lenders and investors are fighting over back-office talent, yet in others mortgage professionals go jobless. One wizened mortgage banker wrote, "This persistent rally is killing margins. You can't push any volume through the baleen filter we call compliance and pre-purchase investor due diligence. So loans stall worse than a Cessna 152 on take-off and eventually get renegotiated. Investors are drinking from fire hoses; so they step on price. This further exacerbates the pain. Loan agents who don't understand the concept of pair-off or roll charges and think mortgage banks are sitting on massive amounts of cash."
This has been a topic of discussion on MND lately: READ MORE & READ MORE
Another broker wrote, "Look at the difference between the mortgage security prices and rate sheet prices. Companies are keeping their profit margins high to cover the added expense - it takes 3x as much time and energy to do a 'vanilla loan' these days. And who is paying the price? The consumer is the one paying the price. And us lenders are paying the price for the indiscretions of those who have, for the most part, already gotten out of the business."
Why aren't large depository banks loosening their credit guidelines and lending more money? Market watchers suggest that one reason is the buy-back issue: FNMA & FHLMC have sizable losses on bad loans and are considering forcing eleven large lenders (the biggest being BofA and Chase) to buy back loans which would result in losses of over $100 billion. Not only are banks grappling with that potential issue, but there may also be a lack of confidence in the health of our economy banks, businesses, and consumers. No one wants to borrow money to buy a house or expand their business if they aren't confident about their job or more optimistic about the economy. And right now, as there often is, investors can't seem to decide if the bond market (which is pointing toward further weakness) or the stock market (pointing toward stability and moderate growth) is more correct about predicting the future health of the US economy.
Stated loans, like the ones a few years ago, have either gone away entirely or are in the realm of private money lending. Many originators agree, however, that the FHA Streamline refi is a pretty close substitute. There is no appraisal, lenders typically don't calculate ratios, and the borrower only has to show they have enough money to cover any closing costs. Of course the original loan must be insured by the FHA, but even if the borrower owes more money than the property is worth, the refi can be done. Usually the lender is paying for the nonrecurring costs and the borrower is bringing in money for impounds and interest.
Under the heading, "The more things change, the more they stay the same", investment banks and "vulture funds" are garnering headlines for securitizing and selling troubled loans. The good news, of course, is that it helps keep the talk of a private mortgage bond market alive, and give servicers an outlet for their bad loans. The bad news, if you want to call it that, is that the pools are made up of delinquent loans rather than original liens. One can expect to see more news about companies with names like Penny Mac, Kondaur Capital, Allonhill, Residential Credit Solutions, Arch Bay Capital, Carrington Mortgage, Equifin Capital, etc., and probably ratings provided by the usual Fitch, Standard & Poors, and Moody's. The process is more conservative this time around (although I don't know precise details), with supposedly issuers having to set aside half or more of their assets as a cushion from loss, while the cash flow goes to the investors.
On the origination side, lending to "subprime borrowers" - non-agency, less than prime, whatever the politically correct term is these days - has either ceased to exist or move to private, individual lenders. The yields have moved higher, which is more commensurate with the risk involved. One may see some of the old subprime players such as Aames, Impac, Option One, Beneficial, etc., spring up when the secondary markets for this product return. And certainly if there is money to be made, probably with lower LTV's and CLTV's, institutional investors will, once again, take a keen interest.
Rates have an inverse relationship with fixed-income prices, meaning that when bond prices go up, rates go down. With the major drop in rates in the last several months comes talk of a "bond market bubble". Most economists do not feel that we're in a bond market bubble where there is a disconnect between prices and fundamental reality, but it is still worth talking about. All bubbles follow a common pattern, whether it concerns high-tech stocks, tulip bulbs, or real estate. Initially prices increase when a new opportunity presents itself with the prospect of good returns. Investors become more optimistic and lenders become less risk-averse. Suddenly everyone is chasing prices regardless of fundamental values, expectations become unrealistic, and speculators who are more concerned with short term gains rather than long term returns flood the market. But clearer minds begin to prevail, and insiders start to sell. Asset prices stop rising, panic sets in, and investors rush to unload positions before the next guy, and prices crash.
In the current case of fixed-income securities, however, fixed-income instruments like Treasuries are not new. There have been good returns, but any excitement is certainly tempered by the fact that the federal government will record a $1.3 trillion budget deficit in 2010, with fiscal year 2010 (ending 9/30) seeing Treasury debt issuance of about $2.3 trillion of which net issuance is about $1.7 trillion. At this point it appears that investors are buying bonds out of fear and from being defensive rather than being excited about bond prices rallying and rates dropping. And as we all know, there is little in the way of credit truly expanding - banks are holding onto their capital. Cash continues to be king - maybe the Fed should charge banks for holding onto capital.
Let's turn our focus to securities and pipeline hedging for a moment. What's the scoop on 3.5% securities becoming more active? After all, the 4% coupon (which contains, basically, 4.25-4.625% mortgages) is trading around 103. 3.5% securities are near par. And when you throw some servicing value on there, whether it is .5 point or 1.5 points, it should present a rebate on the rate sheet for 30-yr mortgages around 4%. But this is not being reflected on the rate sheets, and the production is not there yet enough to calm fears of non-delivery issues. Volume in 3.5% securities has been steadily creeping up, and becoming more liquid, but seller's are still timid of any kind of "short squeeze" if they sell 3.5's out in November or December, and then rates slide up and they don't have the production. On top of that, production is still in the mid-4's, which goes into a 4% security. When profit margins start dropping a little, 3.5% volume should increase.
As the bus stopped and it was her turn to get on, Jill became aware that her skirt was too tight to allow her leg to come up to the height of the first step of the bus.
Slightly embarrassed and with a quick smile to the bus driver, she reached behind her to unzip her skirt a little, thinking that this would give her enough slack to raise her leg. Jill tried to take the step, only to discover that she couldn't.
So, a little more embarrassed, she once again reached behind her to unzip her skirt a little more, and for the second time attempted the step.
Once again, much to her chagrin, Jill could not raise her leg. With a little smile to the driver, she again reached behind to unzip a little more and again was unable to take the step.
About this time, a large Texan who was standing behind her picked her up easily by the waist and placed her gently on the step of the bus.
She went ballistic and turned to the would-be Samaritan and yelled, "How dare you touch my body! I don't even know who you are!"
The Texan smiled and drawled, "Well, ma'am, normally I would agree with you, but after you unzipped my fly three times, I kinda figured we was friends."