January 16th, 2014
in Op Ed
And if they do will this present greater opportunities for the mortgage banks specializing in loan origination as some of their traditional competition suddenly fades away?
by Michael Haltman
Appeared originally 15 January 2014 at Hallmark Abstract Service
The $100 billion question then is whether the proverbial mortgage origination sky is falling and if so whether it is time for multi-service banks to consider getting out of the mortgage loan origination business?
These banks had of course made a great deal of money during the go-go real estate years leading up to the financial crisis that began in 2007 and became a tsunami in 2008 when Lehman Brothers failed.
They have also made a great deal of money since riding the wave with the Federal Reserve's quantitative easing and bond purchase programs that have kept interest rates at artificial and extremely low levels.
These same low-interest rates set-off a consumer driven push to refinance mortgages at rates not seen for decades although it was somewhat constrained by underwater mortgages and stricter underwriting and credit guidelines.
Now, with the Fed talking about tapering its bond purchases (recently reduced $10 billion a month) and with the resulting rise in interest rates choking off refinancing along with new mortgage loan regulations that were put into effect on January 10, 2014, is it time for these same banks to take a step back from originating mortgage loans?
While we don't know the actual answer to that question it is unlikely that the banks would ever completely leave the market, but might instead adjust their underwriting standards to achieve a similar result.
Whatever happens though, change for some always brings opportunities for others as Hallmark Abstract Service can attest to as the firm took advantage of the turmoil caused by the 2008 financial crisis to enter the New York State title insurance market.
So to make a long story short, the following are the reasons presented in an article at American Banker for why banks should consider leaving the mortgage market:
Interest Rate Risk: Mortgage rates have been dropping for 30 years, and it's a good bet that they've already hit their bottom with only one direction to go. Mortgage banking operators always claim to be fully hedged, but sudden spikes in interest rates seem to always catch some of them off-guard. Managing pipeline risk is much different than basic asset-liability matching, and one bad month can and often does wipe out the profit from six to eight good months.
Earnings Volatility and Refis: Mortgage earnings are generally joined at the hip with loan volume, and loan volume is greatly driven by refinance activity. My firm did a study of past refinance waves, and from the peak of a refi boom to the next quarter bust, the drop-off in volume ranged from 84% to 93%. Overall mortgage volume has already dropped 50% to 60% at many banks, with more decreases likely to come.
Effect on Bank Multiples: Mortgage banking is like the little girl in the nursery rhyme: "When she was good, she was very, very good, and when she was bad, she was horrid." When rates are low and volume high, mortgage banking profits are unbelievably great, and generating a 1.5% return on assets is not uncommon. Unfortunately, these profits can disappear overnight and even turn into losses, and the markets often acknowledge this risk by according a lower multiple to mortgage banking-oriented depositories. Not much is accomplished if you double your earnings but see your price-to-earnings multiple potentially cut in half.
Compliance Risk: Does this really need an explanation? The Consumer Financial Protection Bureau's Supervision and Examination Manual is well over 900 pages, and most of it is devoted to mortgage lending. If you retain the servicing rights when you sell your loans, it gets even more complicated. The broader issue is that mortgage compliance is extraordinarily complex, and as someone once put it, if you're dabbling in the mortgage business, you can't be a dabbler anymore.
Repurchases: It used to be that once you sold a mortgage loan, you were typically done with it forever. That's no longer the case. The last five years have devastated lenders that have had to re-purchase loans they had previously sold. Buybacks have slackened, but the point is that this is a whole new area of risk.
Do You Really Need to Offer Mortgages? One of the great myths of our industry is that a mortgage is the foundational product for consumer relationships. With many people having their mortgage payment automatically taken from their checking account, a significant number of borrowers don't even know who their mortgage lender is. And mortgage borrowers are much more interested in getting the lowest rate than in getting a mortgage from their primary bank.