Bloomberg News

Refinancing Seen Peaking Without More Capacity: Mortgages

July 20, 2012

Investors Bet U.S. Refi Boom Has Limited Room to Grow

Hundreds of mortgage firms failed from 2006 through 2008 as real estate slumped. Survivors including Bank of America Corp. and MetLife Inc. shrank or exited in the past year, while market leader Wells Fargo & Co. added staff to deal with a flood of demand. Photographer: Patrick Fallon/Bloomberg

Mortgage-bond investors are betting the U.S. refinancing boom has little growth left, even with rates at record lows and President Barack Obama’s administration taking steps to widen access.

Government-backed mortgage securities reached a record 108.6 cents on the dollar yesterday. Anyone bidding more than face value risks taking a loss if too many of the underlying mortgages get paid off early, so the willingness of buyers to pay those prices shows they expect restrained refinancings.

Efforts by Obama and Federal Reserve Chairman Ben S. Bernanke to help homeowners get cheaper loans and spur the economy have been slowed by lack of staff at lenders and less competition. Refinancings will rise 4.1 percent this year to $894 billion, the Mortgage Bankers Association projected last month, compared with 2003’s record of $2.5 trillion, when former Fed Chairman Alan Greenspan spurred lending to end a recession.

“The only way for things to really change is if lenders add a significant amount of capacity back into the system, and I don’t see that happening over the short term,” said Scott Buchta, the Chicago-based head of mortgage strategy at Sandler O’Neill & Partners LP. “The fear of higher rates has kept the rate of expansion in check.”

Refinancing is also being curtailed as the gap widens between bond yields and new-loan rates, which keeps the cost higher and limits the number of borrowers for whom a new mortgage makes sense.

Failed Lenders

Hundreds of home lenders failed from 2006 through 2008 as real estate slumped. Some of the survivors, including Bank of America Corp. and MetLife Inc., have reduced their presence or exited entirely in the past year. Market leader Wells Fargo & Co. (WFC:US), which produced one of every three mortgages in the first quarter, added staff to deal with a flood of demand.

A weekly Mortgage Bankers Association index of applications has hovered near a three-year high in the past month, while remaining 47 percent below the 2003 record. Prices averaged 108.6 cents on the dollar yesterday for the $5.4 trillion of mortgage bonds guaranteed by taxpayer-supported Fannie Mae and Freddie Mac or U.S.-owned Ginnie Mae, up from 107.59 at the start of the year, according to Bank of America Merrill Lynch index data.

The previous peak of 108.56 came in August 2011, just before the Obama administration began to encourage more refinancing among government-backed loans made during the boom. That was aimed at homeowners previously prevented from getting new loans because the value of their houses had dropped too far to qualify under traditional terms.

Recent Vintages

Some of this year’s gains for mortgage bonds reflect more recently issued debt. Fannie Mae’s 4.5 percent securities contain mortgages with average rates of 4.95 percent and ages of about 3 years, which means they were issued after credit standards were tightened and the steepest part of the housing crash was over.

Home prices are down an average 34 percent since July 2006, according to the S&P/Case-Shiller 20-cities index. Since 2009, the index is down just 8.8 percent. The average rate on a typical 30-year mortgage fell to 3.53 percent this week, down from 3.95 percent at the end of 2011, Freddie Mac data show.

With bond prices exceeding 108 cents, an investor would lose 8 percent if all the underlying loans theoretically were refinanced tomorrow. The average prepayment speed on fixed-rate agency mortgage securities rose last month to a pace that would retire 23 percent of the debt in a year, up from 20 percent in January, Bank of America data show.

‘Borrower Fatigue’

In July 2003, prepayment speed peaked at 58 percent, when about 80 percent of mortgages were carrying rates at least 0.5 percentage point higher than those available on new loans -- the same as in today’s market.

Today’s more subdued pace partly reflects “borrower fatigue” after years of new record lows on mortgage rates sparked repeated refinancings, according to Satish Mansukhani, a strategist for Charlotte, North Carolina-based Bank of America Corp. (BAC:US) Some homeowners are waiting for rates to fall even more as the Federal Reserve signals it may buy additional mortgage bonds, Mansukhani said.

“There will be an increase in prepayments, but it’s still a fraction of what it could have been,” Mansukhani said in an e-mail.

Another hurdle is tighter credit standards from banks, which have been presented with demands to buy back more than $80 billion of existing loans because of underwriting errors. Lenders are contractually required to repurchase loans if they were based on faulty appraisals, false data about borrowers or paperwork mistakes.

Bernanke on Buybacks

Bernanke mentioned the buyback issue in testimony to Congress this week after outlining the central bank’s options to stoke the economy, including additional mortgage-bond buying. Bank of America, which has scaled back home lending after more than $40 billion of costs tied to faulty mortgages and foreclosures, said outstanding buyback claims surged by more than $6 billion last quarter to $22.7 billion.

“With that hanging over their heads, they’re really, really defensive,” said Terry Wakefield, a mortgage industry consultant in Mequon, Wisconsin, who helped start a home lending unit for a Prudential Financial Inc. predecessor. “Lenders just keep asking for more and more and more documentation, not because they think it has any value but because they think it will help them if there’s a buyback demand.”

For homeowners, that’s made the process of getting a loan more onerous, dissuading some from trying to replace their debt, and strained the industry’s limited capacity to process the paperwork, he said. It’s also getting more expensive. Origination and title fees on a $200,000 loan averaged $4,070 last year, up from $3,118 in 2008, Bankrate.com surveys show.

Exit Strategy

The role of third-party mortgage brokers, who once “aggressively sought to refinance their clients as soon as rates fell,” has also diminished, Buchta said.

Brokered loans accounted for 9.4 percent of industry originations in the first quarter, down from 31 percent in 2005, after withdrawals by lenders including New York-based JPMorgan Chase & Co. (JPM:US), the biggest by assets in the U.S., and No. 2-ranked Bank of America, according to newsletter Inside Mortgage Finance. San Francisco-based Wells Fargo said this month it would also leave the business.

Flat or falling home prices have diminished the incentive to refinance, too. The share of Freddie Mac refinancings in which borrowers take cash out fell to 3.1 percent in the first quarter, from 31.1 percent in mid-2006, according to the McLean, Virginia-based company.

In some cases, the lower prices disqualify homeowners who owe more than their properties are worth, even after U.S. efforts to expand eligibility for refinancing programs.

Application Imbalance

“We have far more applications than can qualify, because so many people are underwater,” said Brian Simon, chief executive officer at Caliber Funding LLC, a lender backed by private-equity firm Lone Star Funds.

The Obama administration’s effort to expand eligibility focuses on loans already backed by the government. Some homeowners who hold more than 30 percent of mortgages still can’t qualify because their loans lack that status, Simon said. Others face challenges because the banks to whom Caliber sells its mortgages often won’t accept loans made under Fannie Mae and Freddie Mac’s expanded Home Affordable Refinance Program that they don’t already service, in part because they’d take on debt that’s more prone to defaulting and becoming costly to manage.

The number of HARP refinancings this year totaled 297,103 through May, up from 400,024 in all of 2011, according to a report by the Federal Housing Finance Agency. The Federal Housing Administration last month adjusted its rules on insurance premiums to help similar borrowers.

Yield Gap

Lenders can also manage their capacity by not lowering the rates offered to consumers as fast as declines in bond yields, reducing demand while boosting margins. The gap between the cost of 30-year loans and yields on Fannie Mae mortgage securities into which they get packaged has widened to about 1.3 percentage points, from an average of about 0.7 percentage point last year, according to data compiled by Bloomberg.

The difference, known as the primary-secondary spread, helps determines lenders’ profit margins and can vary based on competition. Wells Fargo, which added the equivalent of about 2,000 mortgage workers last quarter, recorded gains of about 2.25 percent on loans it sold, up from 1.9 percent in 2011’s fourth quarter, according to comments by Chief Financial Officer Timothy J. Sloan in conference calls (WFC:US) in April and this month. Programs such as HARP may support demand for a longer period during this refinancing cycle, Sloan said on July 13.

Citigroup Margins

Citigroup Inc. (C:US) Chief Financial Officer John Gerspach called (C:US) the margins “still well above the historical levels” on a conference call this week. In 2007, Countrywide Financial Corp., the then-market leader and later bought by Bank of America, reported a margin on prime loans of 0.80 percent.

Michael Bauer, a San Francisco Fed economist, signaled in a May paper the central bank was aware that its purchases of mortgage-backed securities might have a limited impact when it came to helping homeowners. Bauer highlighted the “weaker link between MBS yields” and actual loan rates, and said the disconnect “may persist for some time.”

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editors responsible for this story: Rob Urban in New York at robprag@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • WFC
    (Wells Fargo & Co)
    • $52.9 USD
    • -0.46
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  • BAC
    (Bank of America Corp)
    • $17.03 USD
    • 0.08
    • 0.47%
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