Having absorbed heavy criticism for loosened underwriting standards and aggressive lending practices that helped trigger the subprime market collapse, the mortgage banking industry appears poised to move forward by embracing its more conservative past.
As mortgage banks continue their massive hemorrhaging during the global credit crisis, a recovery is still far from eminent. But a number of people in the business believe the return to basics is already in full swing for the industry.
"I think the rating agencies are very vocal about looking at credit quality and reigning things in a little bit," said Jan Sternin, senior vice president, for the Mortgage Bankers Association. "There has been some movement that would support a move toward more conservative underwriting style."
The housing slump continues unabated, of course, as the credit crunch grows and home prices continue to decline. According to a November reading by the National Association of Home Builders/Wells Fargo Housing Market Index, builder confidence in the market for new single-family homes is at its lowest point since 1985.
The MBAs own reading showed a 4.3 % drop in applications to buy a home or refinance a loan for the week ending Nov. 23, as compared to the previous week. The National Association of Realtors is reporting its lowest home sales numbers in years. On the commercial side, the MBAs third quarter report showed a 28% decline in CMBS originations from the same quarter in 2006.
Despite the doom and gloom permeating the market, Sternin emphasized the fact that there are still borrowers looking for loans, and the mortgage banks are still around to service them. So the business is still there, its just the nature of the business that is changing, according to Sternin. "The lending cycle does not stop," she said. "Youve got loans that will mature in 08 while the markets are very tight and very quiet and those mortgage bankers are going to be out there trying to find dollars for their borrowers to refinance loans."
When an event like the subprime collapse happens, Sternin noted, the industry responds with a flight to quality. This means lower loan to value and an emphasis on stronger properties will likely lead to higher quality loans. "It's kind of where the conduit was when it first started," said Sternin. "It used to be very vanilla loans, very simple structures, and you didnt have the highly leveraged products. I think that's what you're going back to as the markets continue to readjust."
One California-based market participant predicts lower purchase originations and a drastic drop in available affordability products. He also sees an increase in fix-to-fix and fix-to-ARM refinancing. "It's going back to an industry of very straightforward underwriting standards," he said. "It's just going to be very expensive or impossible to get anything other than a full-doc, 80% LTV loan for someone with a 700 FICO score."
Jamie Woodwell, senior director of research and business development for the MBA, said that even as the markets have suffered, the fundamentals of loans and bonds remain very strong, delinquency rates are at historic lows and the ratio of upgrades to downgrades was favorably balanced to upgrades. The most significant change over the last quarter has been a return to more traditional lenders-life companies, portfolio lenders, Fannie Mae and Freddie Mac-as the CMBS conduit market has slowed.
Woodwell said a lot of the mortgage banks have diversified their capital sources and more mortgage banking firms that have outlets across the different investor groups and can originate loans for the life companies, for the conduits and for commercial banks. "[The mortgage banks] have the ability to help the borrower pick the capital source that best fits their needs. That's one of the fundamentals of mortgage banking," he said.
While some are touting a return to fundamentals, others in the industry argue that the mortgage banks never drastically changed in the first place. Lou Barnes, an owner of Boulder West Financial Services, said that "nothing unusual" has happened in mortgage banking. "It should be becoming clearer every day that this was a Wall Street event," he said. "This whole 2006-2007 escapade in mortgage finances is one of those rare moments where investors are sucking investment products out of lenders' hands."
Barnes added that the credit panic, the suspect values of securities and the murky worth of portfolios are tied to the "dysfunction" of investors. "None of that has anything to do with mortgage banking as we have known it for more than a half century," he said.
While the mortgage banks return to more conservative, tighter underwriting standards for their lending practices, chances are they will also seek out more traditional avenues for securitizing their loans. The market participant from California said that "back to basics" ultimately means that three quarters of the banks' production is going to be made to the GSEs.
"You can originate to the capital markets very narrowly when you are originating towards the GSEs," he said. "This is assuming the GSEs continue to have enough capital and wherewithal to continue to securitize loans at the pace that we're talking about."
Other market observers agree that Freddie Mac and Fannie Mae will see increased business, but Freddie's recent $2 billion third quarter loss has been a jolt. "Their crucial role is as a guarantor of mortgages and securities, not as an owner," said Barnes. "In the last week as their portfolio quality has fallen into question, their credit has come into question. If their credit is in question that their guarantees are not as good as they were."
Barnes expects to see changes in securitization, arguing that "a colossal credit regulatory failure" happened over the last 10 years as credit creation in the U.S. left the banks for Wall Street. "The deepest flaw in the nouveau securitization since 2000 is a breach in the merit of securitization," he said. "Securities are designed to make things more liquid and more transparent. The individual home loan is neither liquid nor with apparent value."
As the industry increases its risk controls, it will continue to rely heavily on the credit-rating agencies for data analysis. Moody's Investor Service is looking at "how the data can be improved and how the volume of data can be enhanced and disseminated so there is greater integrity and greater transparency," according to one of the rating agency's analysts. This improvement could include expanding the number of data fields it requests on loans to enhance its risk assessment analysis.
Another Moody's analyst believes the increased data will coincide with the bank's greater focus on risk. "I think it's going to be a return to basics," he said. "You're going to have stronger risk management tools across the board for everybody. It's going to be more of a reliance on the three C's of lending: credit, collateral and capacity."
As the big mortgage banks become more conservative in their underwriting and more risk averse with securitizations, perhaps going unnoticed has been the ability of smaller community banks to thrive even as the markets have tumbled. According to Ann Grochala, director of lending and accounting for the Independent Community Bankers of America, their success is tied to the conservative lending practices they have maintained all along.
"They have always had very conservative underwriting standards and when the real estate market started to take off, they saw their business going down," said Grochala. "But now the pendulum has swung more the other way. They have plenty of capital and they see this as an opportunity to shine in the current mortgage environment."
She noted that community banks are looking for the whole relationship with their customers and want to sell other banking products beyond home loans. So maintaining the long-term business is crucial. "They are going to ask for a much bigger down payment and take a closer look at the customer's financial situation, and what product really works for them," said Grochala.
The bigger mortgage banks appear to be following suit, according the MBA's Sternin. "You can take a look at the market today and all the information coming out of the market from analysts, rating agencies, lenders is there will be a move to a more conservative lending landscape," she said.
In other words, after all is said and done, it could be back to business as usual, say sources. "People are going to want to buy property and sell property," said Sternin. "And that's been the traditional role of the mortgage banker.
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