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Making Money On Mortgages Gets Tough

Many mortgage bankers are awash in a sea of red ink, losing money on home loans as a refinancing slowdown and new regulations erode or eliminate profits.

Will the trouble turn out to be temporary as the industry shifts gears, or will the fiscal flood continue this year? The answer depends partly on which way the housing market shifts, and it highlights some crucial trends affecting homebuyers, sellers and owners. But the Federal Reserve's latest comments on mortgage rates don't bode well for the prospect of continuing low mortgage rates.

Independent banks and mortgage subsidiaries reported a net loss of $194 on each loan that they originated in the first quarter of 2014, down from $150 in profit per loan for 2013's fourth quarter, according to data from the Mortgage Bankers Association (MBA).

"It is a tough time to be in mortgage banking," said Guy Cecala, CEO and publisher of Inside Mortgage Finance.

Cecala says that the first quarter of this year offered several challenges to bankers — slowing volume (particularly in refinancing), rising mortgage rates and new qualified mortgage (QM) rules issued by the Consumer Financial Protection Bureau and enacted Jan. 10.

So bankers needed to trim costs while gearing up for the new QM rules. The new rules define criteria for making loans that qualify for backing by government-sponsored housing enterprises Fannie Mae and Freddie Mac. The rules state that a borrower's total debt-to-income ratio, including the total mortgage payment, can't exceed 43% of the borrower's gross income (before taxes are withheld).

Refis to Originations

"During the refi boom of the last few years, there wasn't much competition, and (there was) plenty of demand. That made fees go up ... and bankers were able to make more money on less production," said Cecala.

However, the refi market began slowing in the second half of 2013. After many homeowners had already refinanced into low-cost mortgages, the average rate on a 30-year loan rose from 3.45% in April 2013 to 4.46% by that August, as tracked by Freddie Mac.

So bankers needed to "retool and focus on the home-purchase market," said Cecala. "Before, 75% of mortgages were refis, now refis are only 30% to 40%" of loans.

At the end of last year, bankers were also incurring costs for new software to manage the QM rules. "The QM standard requires a huge amount of documentation that never existed before," said Cecala.

Marina Walsh, MBA's vice president of industry analysis, said that as loan volume drops, bankers have "fewer loans to disperse the cost per loan." She said that bankers "didn't feel they had ability to cut staff (as volume fell), with new rules coming into effect.

Walsh isn't predicting what will happen in the second quarter or the rest of the year, but she noted, "there have been some newsworthy layoffs at lending institutions.

Walsh also says that banks need compliance experts "checking the checkers" to ensure that they abide by the QM rules and can sell their loans. The MBA said that personnel expenses averaged $5,048 per loan in the first quarter of 2014, up about 15% from $4,385 per loan in the previous quarter.

The new QM rules also cap loan fees and points to 3% of the loan amount. The rules do allow slightly higher fees for small loans. Still, bankers must be efficient in their processing to turn a profit while holding to this fee cap.

"Lenders have hired consultants and bought software (to comply with the new rules), but the ones that are going to survive have to control those costs," said Ken Fears, an economist with the National Association of Realtors. "If they can't, we may see a lot of lenders exiting" the mortgage business.

In the first quarter this year, mortgage originations from all lenders declined an estimated 25% from the fourth quarter of 2013, according to data compiled by the website Mortgage Daily. The site notes that activity has fallen each quarter since the second quarter of 2013 and that lately, several smaller mortgage companies have declined to report their loans data, though they did when times were better.

Among the largest home-lending banks, Wells Fargo (WFC) reported originations of $47 billion in Q2, down from $112 billion a year earlier but up from $36 billion in Q1. JPMorgan Chase (JPM) reported $16.8 billion in originations in Q2, down 66% from a year earlier and 1% from the prior quarter. At Bank of America 's (BAC) Consumer Real Estate Services unit, first-mortgage originations declined 59% in Q2 from a year earlier, "reflecting a decline in overall market demand for refinance mortgages," the company said in its earnings announcement.

Ocwen (OCN) and Nationstar (NSM) round out the top five in servicing portfolios as of Q1, according to Mortgage Daily, though Quicken Loans and U.S. Bank (USB) round out the five largest in originations.

While some lenders are struggling, mortgage specialist Guaranteed Rate of Chicago says it's making money and growing its business.

Privately-held Guaranteed has about 175 U.S. offices. It does only mortgages and mortgage servicing, nothing else. According to Rob Sampson, Guaranteed's chief operating officer, it's making money on loans: "We are, or we wouldn't be in business. That's all we do.

He says that the company has "always had a lot of compliance folks on staff" and was ready for the QM standard, since the industry "had two years to prepare for it.

He also says Guaranteed invested heavily in technology to streamline mortgage processing. "If you leverage technology the right way, you can drive efficiencies," he said. The result? "We funded about $1 billion in the month of June on purchase loans, and that was our biggest month ever," he said. Still, "it's definitely harder to make money now, especially for smaller lenders," said Sampson. "But that's helped us grow. We've had smaller originators join us.

As the foreclosure crisis draws toward a close — and with it the availability of dirt-cheap homes to buy — the real estate market is shifting away from investor dominance and to more purchases by owner-occupants. But the inventory of homes for sale remains tight.

"With prices and interest rates up, investors have moved away from the market," said Gus Faucher, senior economist with PNC Financial Services Group (PNC). "So demand is shifting to more owner-occupied housing.

Investors To Owners

This shift should be healthy for the housing market's long-term stability, but it's another shift that lenders must manage. Faucher added: "There's pent-up demand out there for homeownership," which should help drive sales for "the next couple of years.

With rising home prices boosting homeowner equity, "people are getting values back on their (existing) homes, and they can now purchase another home," said Sampson.

U.S. home price increases slowed in April. The Standard & Poor's/Case-Shiller 20-city home price index rose 10.8% in April from a year ago. That's noteworthy yet still down from the 12.4% increase in the previous month. The average interest rate on a 30-year fixed-rate mortgage slipped to 4.13% in the week ended Thursday, from 4.15% the prior week and 4.37% a year earlier, Freddie Mac reported.

NAR economist Fears believes home sales will improve this year. "We'll definitely have a stronger second half," he said. "We're seeing foot traffic and sales pick up. Also, inventory has been very tight but we're beginning to see it creep up.

The signs of health in housing and the economy could put a damper on the low-interest-rate party, however, by spurring the Fed to curtail bond-buying, which has helped to keep long-term interest rates low.

"If incoming data continue to support our expectation of ongoing improvement in labor-market conditions and inflation moving back toward 2%," Fed chief Janet Yellen said in testimony Wednesday, "the (Federal Open Market) Committee likely will make further measured reductions in the pace of asset purchases at upcoming meetings, with purchases concluding after the October meeting."