Surprising Pull Through Research; Float Down Lock White Paper; Chase May do What?

By: Rob Chrisman • Thu, Jul 17 2014, 10:37 AM

Non-QM loans, investor interest in those higher yielding pools, potential disparate impact as a result of QM rules, eMortgages (or the lack thereof), and the CFPB's impact on credit were all hot topics at The California Mortgage Banker's secondary marketing conference. Consolidation was also a hot topic and this last week we saw a few bank deals go through. Alerus Financial ($1.4B, ND) will acquire Private Bank Minnesota ($143mm, MN) for about $16 million in cash. In Virginia Towne Bank ($4.8B) will acquire Franklin Financial ($1.1B) for about $275mm in stock. And Northwest Bank ($258mm, ID) will buy Regal Financial Bank ($99mm, WA) for an undisclosed sum. For those keeping track, SNL Financial reports the top bank and thrift financial advisors through Q2 in order were Keefe Bruyette & Woods (26 deals for $3.3B in value), Sandler O'Neill (28 for $3.0B), Sterne Agee (13 for $1.0B), Bank of America Merrill Lynch (1 for $676mm) and Raymond James (5 for $478mm).

Those who forget the past are doomed to repeat it. The savings and loan crisis of the 1980s and 1990s was the failure of 1,043 out of the 3,234 savings and loan associations in the United States from 1986 to 1995. By 1995, the RTC had closed 747 failed institutions, worth a book value of between $402 and $407 billion, with an estimated cost to taxpayers of $160 billion per the GAO. What happened? Well, most attribute it to Paul Volcker (Chairman of the Federal Reserve), who helped set the stage for the S&L Crisis in 1979 by doubling the interest rate to reduce inflation. But S&Ls had made long-term loans at fixed interest rates using short-term money. When the interest rate increased, the S&Ls could not attract adequate capital and became insolvent.

We all know that QE is going to end around Halloween, and now investors spend a great deal of time discussing when the Federal Reserve will begin raising short-term interest rates. But how about when it will stop raising them? A Federal Reserve Bank of New York survey of bond dealers shows Wall Street firms see the Fed beginning a cycle of interest rate increases in the third quarter of 2015 and ending it by the second half of 2017 when the Fed's benchmark short-term interest rate has reached 3.5%. No one has a crystal ball, but a survey of 22 bond dealers that trade securities with the Fed saw the Fed continuing to push rates up to 3.75% by the first half of 2018 and on to 4% in the long-run. How will that sit with any bank that owns millions/billions of 30-year fixed rate MBS at 3.50%?

Do you think that rates are going to go up? I am sure that they eventually will. Certainly the groundwork is being prepared for it, and along those lines Mortgage Capital Management has an interesting White Paper titled "Float-down locks as a hedging tool in rising interest rate environment".

While our cat Myrtle is already calling for the resignation of Janet Yellen (something about milk prices being the true indicator of inflation now, I tune her out most of the time), I am more willing to give the new Chairwoman a fairly wide intellectual berth. So it was with some interest that I read Wells Fargo's Economics Group Interest Rate Weekly: Is the Fed Behind the Curve? The group writes, "Yellen Shrugs Off the Recent Uptick in the CPI: Fed Chair Janet Yellen appeared to go out of her way to dismiss any concerns about the recent uptick in the Consumer Price Index. The overall CPI rose 0.4 percentage points in May, while the core CPI rose 0.3 percent. The increases were fairly broad based and followed outsized gains the prior month. With May's gains, the overall CPI is now up 2.1 percent year-to-year, while the core is up 2.0 percent." While many Fed-Watchers continue to estimate a 2015 Fed Funds move, much to Myrtles credit, food prices have risen 18-22% by most estimates.

While we're talking about rates, pipeline flow and management, STRATMOR Group Managing Director Dr. Matt Lind reported the results of a statistical analysis of 2013 Retail channel pull-through percentages covering 69 bank and non-bank lenders. In this analysis, pull-through is defined as the ratio of closed loans to applications. Matt points out that this ratio can be very different from the ratio of closed-to-locked loans as is often reported by secondary hedging firms.

Key high-level findings are that: For the 25 mid-size to large banks in the sample, pull-through for Agency loans was a startlingly high 91.54%. "This reflects both the high-mix and pull-through of HARP loans for this segment of lenders" said Dr. Lind. "But pull-through this high also implies high pull-through for non-HARP Agency loans." Matt noted that the Agency loan pull-through estimated for non-Bank lenders was almost 80%; and the Banks have a significantly higher percentage of refinance loans which recently have had higher pull-through than purchase loans. Matt suggested that, along with other factors, "lower-than-expected property valuations were more likely to cause fall-out among purchase loans than refinances."

Pull-through for Government loans --- at around 60% for both banks and non-banks --- was surprisingly low relative to Agency loans. Several factors may account for this: first, the absence of HARP loans; second, the fact that Government loans are comprised of a higher proportion of lower pull-through purchase loans; third, that Government purchase borrowers have less ability than non-Government borrowers to adjust to lower than expected appraisal valuations; and finally, that Government borrowers may be more susceptible to changing circumstances than Agency or Jumbo borrowers.

Pull-through of non-Agency Jumbo loans at Banks (60.01%) is almost 24% lower than Jumbo pull-through for non-Banks (78.92%). This result is a little surprising, says Matt, since so many larger Banks originate Jumbo loans for their wealth management and private banking clients, arguably with low fall-out. But whereas LOs at Banks typically have access to only the in-house Jumbo offerings, LOs at non-Banks can typically choose or shop Jumbo loans from among several investors. And, with non-Agency Jumbo loan balances averaging 3-4 times that of Agency and Government loans, "we would expect loan officers to work VERY hard to get these loans closed," said Matt.

Looking forward, the elephant in the room, according to Matt, is whether or not the industry will experience a systemic decline in pull-through rates to the 60% to 70% range once Agency pull-through rates are no longer being "jacked-up" by HARP loans. Ten years ago, pull-through rates seemed to be running in the 70% to 80% range. So, if pull-through rates systematically decline, fulfillment costs will rise, thereby putting upward pressure on rates and fees.

While many factors in the business environment may be involved, Matt suggests that, at least through the mid-term, systemically slower long-term industry growth (and the resulting heightened competition) may be key to causing lower pull-through rates. Advance lead generation tools --- for example, trigger leads --- make it possible for lenders, especially a borrower's current lender, to go after their business even after the borrower may have been approved by another lender. This is just one manifestation of a competitive environment in which the watchword is "stealing share."

On the other hand, if servicers get good at being first on the scene when an existing borrower needs a new loan --- which will likely make it much more difficult for other lenders to get an application --- pull-through rates could significantly increase, thus lowering origination costs. "If I had to bet," said Matt, "I'd bet on existing servicers eventually getting much better at being top-of-mind and the first lender to have contact with their borrowers for a new loan." This also means that lenders that do not service or carefully track previous borrowers --- lenders who sell loans servicing released --- will increasingly be competing for "first-time homebuyers." "What makes this problematic," said Matt, "is that lenders that service and retain a high proportion of the next loans done by their borrowers will be able to price very aggressively." Thank you Dr. Lind, and feel free to write to him!

In Denver, in advance of the release of Richey May's Q2 financial benchmarking data early next month, it may be useful to remind everyone of a couple trends from the first quarter. Although production was down and profitability took a significant hit in Q1, there were some positive signs for independent lenders heading into Q2. Richey May reported that locked pipelines were up an average of 41% at the end of the quarter versus the prior quarter, suggesting a rebound in production volume; margins rebounded to where they were during the second quarter of 2013; and pre-tax profits were up by 25 bps over the prior quarter, with lenders that service and direct-to-consumer shops seeing the biggest increases. Although operating expenses on a per-loan basis continue to rise, the rate of growth slowed significantly during Q1. All of this pointed to a much better Q2 after a long, cold winter.

Many times I may receive the same article over the span of a few days; in some cases my inbox gets flooded within an hour by people around the industry pointing to a news article of some interest. This is such a case. Prashant Gopal and John Gittelsohn writing for Bloomberg news, penned an interesting article "Starter Homes in Demand With Builder LGI Soaring 60%: Mortgages" examining the continual strength of LGI. They write, "LGI, an entry-level Texas builder that has moved into six more states, is demonstrating that the U.S. housing crash didn't diminish the desire for homeownership. The company's strategy of luring renters with low-cost houses and assisting them with getting mortgages has spurred record sales and made LGI the top-rated builder among analysts. It's also attracting competition as D.R. Horton Inc. (DHI), the largest in the industry, starts a brand aimed at first-time buyers with prices starting at $120,000." As most know, rents have been skyrocketing, with demand being satiated by a continual supply of underemployed workers battle hardened by debt and continual underemployment over the last six years. According to SF based Trulia, for those who can qualify for a mortgage, buying is now 38 percent cheaper than renting.

Are changes underway in residential lending at Chase? Is JP Morgan is considering getting out of the FHA business? CEO Jamie Dimon said on the second quarter earnings conference call that the bank lost "a tremendous sum of money on FHA... So the real question is, should we be in the FHA business at all? We are still struggling with that." Consider this a brush-back pitch to the government, who has been suing the banks left and right (which is one way to impose a financial surtax). So what does the public see? Here's a Reuters story in the Chicago press titled, "JPMorgan pulls back from mortgage lending on foreclosure worries." So... it doesn't take much pulling back from "the big boys" in lending to make for some great years for scores of smaller lenders around the nation.

Is it newsworthy when Janet Yellen says, basically, "If the economy slows back down we'll leave short term rates alone, but if & when it improves we'll increase short term rates"? I hope not - but there wasn't much else going on yesterday although the Fed's Beige Book showed slow expansion in the nation's economic districts. And homebuilder optimism picked up - a good thing for housing in inventory-strapped areas. The yield on the 10-yr has been stagnant all week, sitting in the low 2.50% range. The market will have June's Housing Starts and Building Permits, expected +1.9% and +3.5% respectively, and Initial Jobless Claims also expected to increase slightly.