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Last week The IRA’s Chris Whalen participated in the Executive Roundtable in San Francisco, hosted by the Morrison Foerster Law firm. We got to hear from a lot of different representatives of the mortgage and fintech sectors. The big worry at the table is that production of new mortgages in 2017 is down about 30% compared with last year due to the rise in interest rates following the November election of Donald Trump.
Trump politics drives interest rates higher and mortgage production falls.
Just as the Executive Roundtable meeting was ending, news crossed the screen that the Consumer Financial Protection Bureau (CFPB) and a number of states were imposing new sanctions on mortgage servicer Ocwen Financial (NYSE:OCN).
CFPB head Richard Cordray (pictured above) was formerly attorney general in OH, where he used his legal power to extract millions in settlements from private mortgage companies. A key political ally of Senator Elizabeth Warren (D-MA), Cordray represents a new generation of liberal politicians who use the power of regulation to impose legal settlements and fines as a means to achieve political power. Trial lawyers and event driven hedge funds follow Warren and Cordray like crows.
White House economic czar Gary Cohn reportedly gave Cordray an ultimatum over dinner a few weeks ago to resign from the CFPB. Cordray declined President Trump's invitation to leave public life and instead launched a new assault on subprime mortgage servicer Ocwen Financial, which was accused last week of operational deficiencies by the CFPB and a number of states.
Regulators have been bleeding Ocwen dry with fines and monitoring costs for years, but this latest move by Cordray amounts to a not-too subtle “Foxtrot Yankee” to the Trump Administration. Just by coincidence, as the CFPB and states announced their action against Ocwen, the stock was simultaneously hit by waves of short-selling from hedge funds and several new class action lawsuits, all this in less that 24 hours.
This week, subscribers to Whalen’s Financial-Technology Investor can read my assessment of the Ocwen situation.
There was much discussion in SF last week about efforts to expand the mortgage credit box. The good news is that interest rates are falling, with the 10-year Treasury now down to 2.2% from the peak of 2.6% several months ago. The tentative bad news, however, is that mortgage volumes are only slowly starting to recover at all from the Trump Bump.
The first quarter of 2017 was for single-family mortgages what Q1 2016 was for commercial real estate asset-backed securities (ABS) – that is, dreadful. Down a lot more than 30% to put it mildly. Mortgage origination pipelines seem to be better in April, however, and mortgage banks are now delivering loans into agency securitizations with 3% coupons instead of the 3.5% coupons seen at the start of 2016. Our friend and TBA market watcher Adam Quinones at Reuters writes:
“The range is no longer the range and while breakout energy has been largely contained thus far, the rally is impacting pipeline hedging strategies. Naked C30 pricing now pays a premium on 3.75 and 3.875 notes. That puts FNCL 3s back in the delivery mix. Once lenders start showing these levels to LOs [loan officers] in size, late 2016/early 2017 borrowers will see their option jump in the money. Swapping coverage down-in-coupon is an aggressive decision at this point but everyone should be preparing for a sudden shock in pull-through volatility. One or two major aggregators flipping to BestEx [best execution] the buyup is all it takes to trigger a mini-churn event here. Don't think originators are that responsive to a small dip in rates? Think again. It was a rough Winter.”
In other words, the attractiveness of selling residential mortgage loans into agency markets is growing as rates fall. More, residential mortgage refinance volumes may come back later in 20017 -- assuming that Washington does not cause another "bump" in interest rates. But watch that interest rate and spread volatility.
Another topic that came up at the Executive Roundtable during discussions of the Trump Bump was whether the major banks and especially JPMorgan Chase (NYSE:JPM) and Bank of America (NYSE:BAC) would re-enter the market for Federal Housing Administration (FHA) loans. The short answer is not yet, both because of concerns about punitive action by the Department of Justice and other, operational factors.
JPM chief Jamie Dimon has been very clear on his views of the Washington situation and the financial and reputational risk that comes from originating FHA loans in his shareholder letters. One suspects that this issue is on a list somewhere in Washington, but the recent actions by the Consumer Financial Protection Bureau (CFPB) against Ocwen Financial hardly inspire confidence in this regard. And the Department of Justice litigations with both PHH Corp (NYSE:PHH) and Quicken Mortgage continue unabated.
But some banks like the FHA market. Mortgage industry Maven Rob Chrisman notes that WFC is already changing pricing on FVA loans to become more competitive:
“Regarding FHA loans, did you see Wells Fargo's price changes for low balance FHA loans this week? (Starting May 1, see how the pricing works for a low-FICO borrower, and you're calculating in a 3, 4, or 5-point hit.) It is generally believed that JPMorgan Chase would return to offering that program on a competitive basis IF the regulatory, and penalty, environment changed. And if they do, the market share will be taken from smaller independent mortgage banks who have been enjoying the profits.”
Chrisman further notes that mortgage banking earnings for JPM, WFC, and PNC Financial (NYSE:PNC) were down in the first quarter but largely in line with expectations. The decrease in Q1 2017 earnings was driven by lower origination volumes, he notes, while gain-on-sale (GOS) margins were mostly flat.
“JPM's mortgage origination volume of $22.4 billion was down 23% Q/Q from $29.1 billion while WFC's origination volume was down 39%. WFC's application pipeline was down 21%, which was slightly worse than expected. Both companies reported flat gain on sale margins,” Chrisman reports.
The bottom line with the big banks and the FHA market is that when the risk-adjusted returns make sense and the threat of government litigation subsides, then the banks will return. So much of banking today is a function of risk-adjusted returns, both operationally and from a regulatory perspective. If the numbers don’t meet the economic and regulatory hurdles, then the banks will shed market share or even get out of the asset class entirely.
Single family home finance has been a chief victim of the emigration of banks out of residential mortgage originations, but the same risk adjusted returns calculus is also pushing many banks out of prime auto lending and ABS. The numbers in prime auto simply do not work when you consider the rising cost of loan origination and servicing, the indirect regulatory risks, and the poor execution into ABS.
The decision by Citigroup (NYSE:C) to sell its mortgage servicing business illustrates this trend. But also recall that WFC got out of residential mortgage lending entirely in the early 1990s. Mortgage lending is a negative cash flow business and servicing too has historically been a cost center at most banks. Legacy banks and non-banks, as a result, both suffer from profound operational inefficiency.
Historically banks could subsidize the lending and servicing businesses, but less efficient non-banks cannot, especially the monoline servicers will no significant lending business. One reason that shops like Flagstar (NYSE:FBC), PennyMac (NYSE:PMT) and new entrant Amerihome, which is owned by insurer Athene (NYSE:ATH), are able to be successful is the fact of being both a lender and servicer. Operating efficiency and capital markets sophistication, however, are other key advantages enjoyed by these relatively new, large and growing platforms.
Another fascinating aspect of the conversation in SF was fintech and how different players were disrupting the established order. We heard presentation from SoFi, who has figured out a way to use restricted stock units (RSUs) from millennials working at tech companies as part of the income calculation for a jumbo mortgage. The logic goes that an RSU counts as income on your taxes, so why not include as part of the assessment of ability to pay and DTI.
Is this a great country or what??
We also heard from Donald Lampe, Partner at Morrison Foerster, on the outlook for regulatory reform. “Not clear where Dodd-Frank reform fits into the Trump agenda, but evidently not in top three,” notes Lampe, who is based in Washington and is an astute observer of the political process. “Dodd-Frank statutory reform is not easy in Congress, especially in the Senate – it’s still gathering steam in the House. And even the Courts (D.C. Circuit) will have a say in any reforms,” he cautions.
Doug Duncan of Fannie Mae and Mike Fratantoni of the Mortgage Bankers Association held forth on the outlook for the economy and the housing sector. Suffice to say that MBA has GDP growth at 2% this year, declining to 1.9% in 2018 and 1.7% in 2019 – even with Trump factored into the equation. They see total loan originations down 25% at $1.6 trillion in ’17 and ’18, then rising back to $2 trillion in 2019. Not good news for originators focused on loan refinancing.
So the basic prognosis for the mortgage industry is that volumes will remain depressed by substantial shrinkage in refinancing volumes, but look for some purchase volume growth as the proverbial credit box widens accordingly. The sudden buzz around new products such as fractional interest mortgages in going to be sustained and grow louder as originators and aggregators look for new and innovative ways to fill the purchase loan pipeline to drive ABS issuance.
In this regard, note the new blog created by Weiss Analytics focused on the US housing sector. The latest blog posting from Weiss notes that “US Housing Crosses the Great Divide” as the number of homes rising in heretofore red hot markets is starting to fall, even as the number of homes falling in value is increasing. Unlike other measures of home price appreciation, Weiss actually values tens of millions of individual homes.
Could the secular bull market in single family homes going back to 2012 finally be ended? Don’t look for home prices to fall very much, but the continuous rise in home price appreciation at multiples of income and GDP growth may have finally outrun consumers’ ability to borrow and pay. But like public stocks, the residential home market faces a persistent shortage of supply, which will likely keep valuations from falling too much in the most desirable locations.