There’s little doubt that 2014 is going to be a tough year for mortgage lenders, something which has been apparent for some time.
In January, the Mortgage Bankers Association predicted that refinancing volume would fall by 60 percent for the year. What could cause this huge decline? Could it be higher interest rates — or at least rates higher than the record lows seen in 2012 and early 2013? Or what about Dodd-Frank and all of its picky rules and regulations?
There might be some reason to blame higher rates and new regulations except that if such claims were true then they would also be true for purchase money mortgages but that isn’t the case. The MBA predicts that demand for purchase-money loans will increase 3.8 percent in 2014.
The real problem faced by the lending industry is very different.
First, refinancing is down because many would-be refinancing candidates have already traded older loans for new ones during the past few years.
Second, home builders keep constructing huge homes — and unit sales are down which means that the need for mortgages is also down. The National Association of Home Builders reports that the average new home now has 2,679 square feet, up from 2,362 square feet in 2009. According to the Census Bureau single-family home sales stood at 1.613 million in 2004 versus an estimated 617,500 in 2013. Could there be a correlation?
Third, the penalties for making sub-par loans are enormous. The lending industry paid out more than $100 billion to settle claims that mortgages sold to investors during the run-up to the foreclosure crisis were not-as-promised. The result: Less emphasis on volume and more attention to accuracy.
We now have the first quarter results from two of the nation’s most significant lenders: JPMorgan Chase and Wells Fargo. Both saw significant reductions in loan originations and this is a substantial problem.
To be in the lending business on a large scale requires a massive infrastructure, an infrastructure which represents a huge fixed cost. The value of this infrastructure is maximized when origination volume is high. Conversely, fixed costs and low origination volumes mean a higher cost per loan.
In considering the news from JP Morgan Chase and Wells Fargo there is every reason to believe that the tide of market conditions which has impacted them has also impacted lenders in general. Indeed, the two financial giants may well have done “better” than most industry participants.
Because a 2014 study from the Federal Reserve Bank of New York found that big is better for the nation’s five largest banks. The New York Fed reported that the biggest banks have a lower cost of funds — 41 basis points lower — than smaller competitors. If big banks are having a tough time in the mortgage marketplace then what about small lenders without massive economies of scale and lower funding costs?
New Beginning For Mortgage Lenders
We are likely at the start of a new era in mortgage lending, a time when the origination numbers and outsized profits of the past decade are unlikely to be repeated simply because of reduced borrower activity.
What can lenders do?
The first idea is to reduce lending standards, something already underway. Figures from Ellie Mae show that average credit scores are now at 724 versus 748 in 2012.
The second approach is to forget about the “qualified mortgage” requirements under Dodd-Frank and instead generate more high-profit, non-QM loans such as jumbo mortgages and subprime loans. It’s worth noting that interest rates for jumbo mortgages have been consistently lower than the rate for conforming mortgages.
The third way to deal with a contracting mortgage marketplace is to close offices and downsize — fire people. JPMorgan Chase, as one example, is expected to reduce mortgage-related staff by an estimated 8,000 positions this year.
In the end, 2014 will likely be remembered as one of the most difficult years in recent memory for lenders. But the good news for borrowers is that tough times show that a less-massive lending system can still provide mortgage capital at low rates.