Refi Boom Drives Profits, But Can It Last?

By Kate Berry

JUL 30, 2012 12:35pm ET

Mortgage refinancings once again drove banks’ profits last quarter and, with interest rates at record lows, most industry experts expect the trend to continue at least through the end of the year.

Still, it is not too soon for bank executives to be thinking about the end of the refi boom. In conference call after call this earnings season, CEOs were asked how they intend to make up for the lost profits when interest rates rise and the number of borrowers eligible to refinance ultimately peters out.

“Margins now are fat and everybody loves them,” says Joe Garrett, a principal at the consulting firm Garrett, McAuley & Co., in San Francisco. “But at some point, everybody who can refinance has refinanced and eventually all parties come to an end.”

Many CEOs were prepared for questions about how they plan to offset an inevitable slowdown in mortgages, saying they are diversifying their revenue streams, expanding into new areas of lending and, of course, cutting costs. Joseph Campanelli, the chairman and CEO at Flagstar Bancorp (FCB) in Troy, Mich., repeatedly used the word “diversify” to explain how the $14.4 billion-asset bank plans to sustain the momentum generated by mortgage originations. Flagstar posted its first quarterly profit in four years in the second quarter, thanks by a 170% jump in residential mortgage originations from the same period last year.

“We continue to use strong mortgage banking revenues to help fuel the growth in other lines of business” – primarily commercial lending – “thus diversifying and lessening the volatility of our revenue streams over time,” Campanelli told analysts.

In the short-term, refinancing activity is expected to continue to drive profits. Refi applications soared to their highest level last week since 2009 as the average 30-year fixed-rate mortgage dropped to new lows of 3.74%, according to the Mortgage Bankers Association. Refinancings now make up a whopping 80% of all mortgage applications while home purchases remain anemic by historic standards.

“Both the first and second quarters were really strong and we really haven’t seen pipelines slowing,” says Jeffrey Harte, a principal at Sandler O’Neill & Partners. “With rates getting as low as they are, refinancing is again economically viable, kicking in a whole new wave of borrowers who have already refinanced and are doing it again.”

On top of borrowers refinancing at ultra-low rates, the largest mortgage servicers have been inundated since January with a wave of new refinance applications for the revised Home Affordable Refinance Program, known as Harp 2.0. The program has help mostly underwater borrowers with high loan-to-value ratios who previously could not refinance and whose loans are guaranteed by Fannie Mae or Freddie Mac. Harp 2.0 program has brought in an additional 25% of all refinance applications. It also has been criticized for boosting big banks’ profits.

Several other factors may help sustain strong mortgage revenue and profits into the second half. Other than Wells Fargo (WFC), the nation’s largest retail mortgage lender, most banks are not adding much additional staff to handle the increased volume. Scott Buchta, head of mortgage strategy at Sandler O’Neill & Partners, says a 50-basis-point rise in interest rates could lead to a dramatic drop in refinancing applications and banks simply do not want to be stuck with too much staff when the refi boom slows. Plus less overhead means higher profits.

“Capacity is being built, but banks don’t want to build it fast so it doesn’t disrupt primary-secondary spreads,” says Buchta, referring to the difference between the cost of 30-year loans and yields on Fannie Mae mortgage securities that determine lender’s profit margins.

Also, Wells Fargo’s exit from wholesale lending and Bank of America’s (BAC) exit from correspondent lending has allowed smaller lenders to add market share.

Wells Fargo’s mortgage banking income in the second quarter jumped 79% from a year earlier, to $2.9 billion, contributing 63% to the San Francisco bank’s total earnings of $4.6 billion in the second quarter. Its originations more than doubled to $131 billion year-over-year as its pipeline of loans hit $102 billion at the end of the quarter.

Chris Marinac, an analyst at FIG Partners, says that banks’ mortgage pipelines “were pretty darn full at the end June,” which bodes well for third-quarter profits, but eventually banks will be forced to cut expenses to replace strong mortgage revenue.

“This industry needs to get leaner and meaner and there is plenty of fat to trim,” he says. “The CEOs know it and low interest rates pressuring net interest margins and the eventual slowdown in mortgage fees is going to have to focus back on process improvements.”

McAuley & Co.’s Garrett says that while there’s enough refi demand to sustain profits through early next year, banks need to be preparing now for the eventual rise in rates. He advises clients to create board-approved exit plans with clear definitions and specific steps to take when rates rise and refi demand slows. Such plans would kick in when mortgage applications drop by a certain percentage for several consecutive weeks, which could help banks avoid widespread staff cuts.

Still, Willie Newman, president of Cole Taylor Mortgage, a unit of Taylor Capital Group (TAYC) in Chicago, says banks that are truly committed to mortgage lending can only cut staff so much.

“It takes more people to process an application and there’s a higher degree of scrutiny for every data point and loan file,” Newman says. “The whole industry is just harder.”

Mortgage lending once again drove profits at the $4.8 billion-asset Taylor Capital, but the company continues to strive for balance. It recently opened a commercial lending office in the Milwaukee area, its second in Wisconsin, and just launched a nationwide equipment leasing division targeting middle-market firms. The unit is headed by Edward Dahlka, the former president of LaSalle National Leasing in Towson, Md., where Taylor’s new leasing arm is also based.

“I’ve known Ed for many years, and the highly experienced team has an established network in the marketplace,” Mark A. Hoppe, Cole Taylor’s president and CEO, said when the division was launched in July. “We expect that Cole Taylor Equipment Finance will become a strong source of balance sheet growth and fee revenue for the bank and further contribute to the diversification of our earnings.”

The Return of supply and demand

By KENNETH R. HARNEY Jul 27, 2012

Though many home shoppers who assume they are still in a buyer’s market find it hard to believe, one of the sobering fundamentals shaping real estate this summer is shrinking inventory: The supply of houses for sale is down significantly in most areas compared with a year ago, sometimes dramatically so. And that is having important side impacts – raising prices and homeowners’ equity stakes, and reducing total sales.

In major metropolitan markets from the mid-Atlantic to the West Coast, the stock of homes listed for purchase is down by sometimes extraordinary amounts – 50 percent or more below year-ago levels in several areas of California, according to industry studies. In Washington, D.C., and its nearby suburbs, listings are down by 28 percent, reports Redfin, a national online realty brokerage. In Los Angeles, available inventory is 49 percent lower than it was last summer, San Diego by 53 percent. In Seattle, listings are off by 41 percent. According to the National Association of Realtors, total houses listed for sale across the country in June were 24 percent lower than a year earlier. The dearth of listings is often more intense in the lower- to mid-price ranges, less so in the upper brackets.

Peggy James, an agent with Erick & Co. of Exit Choice Realty in Prince William County, Va., says she gets calls “all the time” from buyers asking, “Where are all the new listings? Are you agents bluffing” – holding back? But the reality is that “there just haven’t been many” listings in some high-demand price categories lately, she says.

In Orange, Calif., Carlos Herrera, broker-owner of Casa Blanca Realtors, says “it’s really strange right now. We have many buyers but few sellers,” forcing purchasers to bid up prices on what’s available.

Just south of San Francisco, Redfin agent Brad Le says inventory in Silicon Valley is down so drastically – and demand so strong – that the bidding wars are spinning off the charts. “We’re not just talking about 10 or 15″ offers, he says, “but sometimes 40 and 50.” Some buyers are inserting escalation clauses into their contracts to keep pace with counter-bids, and waiving financing contingencies, inspections and even agreeing to increase their down payments to counter any differences between the accepted sale price and the appraised value. One modest, 1,700-square-foot house recently was listed at $879,000. It drew more than 50 competing offers and sold to an all-cash buyer for $1,050,000 in less than a month.

Silicon Valley is in its own special economic niche, but declining inventories are nationwide. In its latest survey of 146 large markets, Realtor.com found that 144 had lower supplies of listings last month than a year earlier. Online real estate and mortgage data firm Zillow reports that some of the steepest declines in inventory are in places that got hit the hardest during the bust, and where sizable percentages of owners still are underwater on their mortgages. In Phoenix and Miami, for example, 55 percent and 46 percent of owners respectively have negative equity.

Both cities have seen significant drops in inventory, and both are experiencing strong appreciation in home prices. According to data from research firm CoreLogic, Phoenix prices are up 14.7 percent for the year and Miami by 9.7 percent.

What’s behind the widespread declines in listings? Analysts say negative equity plays a major role – it discourages people who might otherwise want to sell from doing so. They don’t want to take a big loss, especially in a slowly improving price environment. So they sit tight rather than list. Banks with large stocks of pre-foreclosure and foreclosed properties are doing the same, creating a so-called “shadow inventory” of houses estimated to total 1.5 million units.

Where’s this all headed? Stan Humphries, chief economist for Zillow, says the likely trend is for more of the same: Constricted supplies will lead to price increases, especially in segments of local markets where demand is strongest. Longer term, price increases will gradually rewind the cycle, increasing owners’ equities and convincing more of them to list and sell. This, in turn, should put a brake on price increases, especially under today’s super-strict mortgage underwriting and appraisal practices.

Bottom line for anyone looking to list or purchase anytime soon: Though conditions vary by location and price segment, lower supplies of houses available for sale are changing market dynamics – putting sellers in stronger positions than they’ve been in years.

Cordray Escapes Congressional Lion’s Den

By Kevin Wack

JUL 24, 2012 5:31pm ET

WASHINGTON – For all the hostility that congressional Republicans have directed at the Consumer Financial Protection Bureau, the agency’s director appears to be adept at escaping their wrath.

Richard Cordray faced off Tuesday against the congressional panel most suspicious of his agency, an oversight subcommittee chaired by GOP Rep. Patrick McHenry. While Cordray did not exactly get a hero’s welcome from the panel’s Republicans – one called him “condescending” – the hearing was largely substantive and respectful, with McHenry going out of his way to praise him for his cooperation.

“Your actions serving in this position have been honorable, even if at times I’ve disagreed with the actions you’ve taken,” said McHenry, who chairs the House subcommittee on financial services oversight.

The scene was far more civil than what unfolded in May 2011, when McHenry accused Elizabeth Warren, who was then setting up the consumer bureau, of essentially lying about the agreed-upon terms of her appearance.

McHenry was primarily interested in using the hearing on Tuesday to assess the CFPB’s impact on the availability of credit in the U.S. economy, arguing that overregulation is choking off the supply of loans from financial institutions.

Cordray disputed that point, saying the financial crisis caused the credit crunch, and noting that the CFPB has only finalized one new rule at this point. But he also acknowledged that the regulatory pendulum can swing too far in the wake of a crisis.

“Can people overreact, and can they potentially compound the problem? I think that is always a possibility,” Cordray said. “So we need to be careful about what we are doing.”

McHenry acknowledged that Cordray had a point about the role of the financial crisis, proving the two sides could find more common ground than might have been expected just a few months ago.

Still, there were a few moments when Republicans turned testy.

Rep. Ann Marie Buerkle, R-N.Y., accused Cordray of condescending to the American people by implying that they can’t take care of themselves without the help of the federal government.

“First of all, it’s condescension. But second of all, it’s such 180 degrees from what this country is about,” Buerkle said.

Cordray took umbrage with that characterization, saying that many Americans have been victimized in recent years by abuses in the financial services industry.

“So the idea that everything is working fine if we can just get the federal government out of the way cannot be squared with the facts,” he said.

Rep. Mike Kelly, R-Pa., also got into a heated exchange with Cordray over the impact that CFPB regulations are having on small financial institutions.

To make his point, the GOP congressman held up the nearly 1,100 pages that the consumer agency released in connection with its effort to consolidate existing mortgage disclosure forms. He said that it is ludicrous to think that community banks can go through all of those pages.

“It’s not making it easier. It’s making it more difficult,” Kelly said.

Cordray said many of those pages were included to satisfy demands imposed by Congress and requests from financial institutions. Reading all of them isn’t necessary, he said.

“We’re not asking anybody to go through 1,100 pages,” Cordray said. “Industry often tells us that they want us to be very specific. Specificity means greater length.”

But Kelly wasn’t buying it.

“While we debate, they’re dying,” he said, referring to small banks.

McHenry also questioned Cordray about the bureau’s use of behavioral economics, a field whose findings suggest that consumers will make more prudent choices when they are offered subtle encouragement in that direction.

The North Carolina lawmaker said that he is greatly concerned that regulators, using behavioral economics, will seek to limit the options available to consumers.

In response, Cordray said that the agency is trying to incorporate behavioral economics into its work, in part because private industry is doing the same thing. But Cordray also added, “We have really not been thinking of banning products per se.”

McHenry also pressed Cordray on what he characterized as the lack of detail provided by the agency so far regarding what constitutes an abusive business practice, a sore point with bankers who are looking for clear guidance about what is allowed.

“Do you have an intention to lay this out in rulemaking in a formalized way?” McHenry asked.

Cordray responded: “I think at the moment we have no present intention to launch a rulemaking on that issue.”

Seizing on the same subject, Buerkle warned that if the CFPB won’t define abusive, “how are banks supposed to know what it is?” She said the ambiguity was having a “chilling” effect on lending.

The only point in the hearing when Cordray seemed to be caught off-guard was when McHenry asked him about any contacts he has had with Assistant Attorney General Thomas Perez regarding fair-lending cases.

McHenry explained that he is investigating whether the Justice Department influenced a decision late last year by the City of Saint Paul, Minn., to drop a Supreme Court appeal that might have made it harder for the government to bring fair-lending cases against banks.

Before the appeal was dropped, liberal groups feared that the Supreme Court would strike down the use of a legal theory that allowed such lawsuits based on a statistical analysis of lending patterns if there is not also proof of discriminatory intent.

Cordray replied that he knows Perez, who heads the Justice Department’s Civil Rights Division, and their agencies have been working with each other on certain issues. McHenry requested that the consumer bureau turn over records of contacts between the two agencies.

Eminent Domain, Eminently Suitable for Defaulted Loans

Andrew Kahr

JUL 24, 2012 12:30pm ET

A remarkable result of the housing crash has been the revelation that although local governments retain legal authority over real estate – taxes, title, recordation, foreclosure – 100% of them lack the will or the way to protect constituents from a horrific, slow-motion disaster.

If they won’t use their powers constructively, then reduce complexity by having Washington centralize all this – such as title registry. That might even save money and thin the fog.

But Washington has done little that has been quantitatively effective in reducing the enormous costs and collateral damage associated with forcing out owners and throwing properties on the market.

Now comes a new idea: San Bernardino County, California, is considering acquisition by private investors via eminent domain of home-secured loans, to protect homeownership while delivering the market value of the old loans to their owners.

Many vested interests, starting with large banks and other investors who don’t want to recognize losses, particularly on second lien loans, object vociferously to getting paid off at market. That’s odd if their accounting is honest-but they’re entitled to pursue their perceived self-interest. The people of our political subdivisions are likewise entitled to exercise their legal rights.

What legal rights? According to some commentators, this program is unconstitutional. First we are told eminent domain doesn’t apply because there is no “public purpose.” Ridiculous excuse. Protecting and improving neighborhoods, as with eminent domain for urban renewal, is a well-tested public purpose.

Second we’re told that the program breaches the “sanctity of contracts.” Indeed it does. After prior misreading of the Fifth and Fourteenth Amendments, state legislative enactments have breached the “sanctity of contracts” to serve a public purpose with support from the Supreme Court since 1937 (West Coast Hotel Co. vs. Parrish). Now we again have what that Court referred to as “unparalleled demands for relief.”

I do not argue for the specifics of the San Bernardino plan, but rather for flexible use of eminent domain, which fits specific classes of situations such as: The homeowner can’t pay on his current mortgage loans, but he’s able and willing to pay on a new mortgage loan with value at least as high as the reduced market value of his present loans.

A concrete example: Suppose the customer’s payments under a 30-year government-backed fixed-rate mortgage, plus home equity loan – averaging a 6.5% rate – aren’t affordable. He’s paying only on the home equity. The total market value of the loans is only 50% of the balance.

Maybe he can make the much smaller payments – approximately half as large – under a new mortgage with no reduction in principal, but interest-only payments for 10 years with initial rate of 3.25%. This isn’t a modification. It’s a single new mortgage which should receive the same government backing, since it’s more affordable.

Between the mortgage servicer settlement, legacy Countrywide, investors and various federal interventions, the refinancing of the old mortgages doesn’t get done. So, the borrower, even after being magnanimously accorded the highly-touted advantages of “single point of contact” and “no dual tracking,” is likely to lose his home.

Fix this: Cut the fiddling with securities trustees and owners of seconds. If the holders of the existing loan can give the borrower a better deal than the outside investor proposes, let them do so. Otherwise, the investor gets the loans.

Why does this idea upset almost everyone? First, it requires the current owners of the debt to recognize their losses. Maybe up to now their accountants and regulators have helped or allowed them to avoid this.

Second, the servicers who have been paid to mess with these mortgage problems-ineffectually, but profitably – don’t want the game moved off their turf.

Then, there are the special pleaders who insist that the right solution always requires reducing principal to or below market value of the home. Reduce the principal every year? Every day? Somehow, it’s OK to lose money on your investment or pension account, but never on your home.

Rates have dropped precipitously. Reducing the interest to market – which, under our inherited system, has become virtually a fundamental right of homeowners – is just too complicated without eminent domain because of the multiple consents required. Let’s cut the knot, chop up the obsolete papers, and reduce the overhang of vulnerable mortgages. Next go after the mortgages on unforeclosed, abandoned properties that are not being maintained.

Washington isn’t motivated to do this. Get out of the way and let governments that are closer to the people and have more direct eminent domain power do it.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.

Has the CFPB Done a Good Job in Its First Year? Poll Results

JUL 20, 2012 6:47pm ET

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