Breaking the Residential Mortgage Origination Logjam

by 02 Jul 2012

It has been nearly five years since the housing market bubble burst, and a vigorous recovery has yet to take hold.  Yet the culprit is not, and has not been for some time, the affordability of mortgage loans.  In fact, Freddie Mac, the government-guaranteed source of much of the mortgage lending pool, reported in early May of 2012 that the average 30-year fixed mortgage rate (3.84%), the 15-year fixed rate (3.07%), and the one-year adjustable mortgage rate (2.70%) were all at record lows.[1]

But even though record-low mortgage rates mean banks are seeing stronger demand for home loans, those banks are not loosening their tight credit requirements, according to the Federal Reserve's April 2012 survey of senior loan officers at more than 80 selected banks around the country.  The survey found more than 90% of the bank respondents made basically no change during the three previous months in their credit standards for prime home borrowers – those who have relatively high credit scores and well-documented financial statements. And for nontraditional residential loans, which include interest-only mortgages and "alt-A" products with limited income verification, credit standards had tightened.[2]

What we have here, in the classic line from the movie Cool Hand Luke, is failure to communicate.  If money is available to lend, why are lenders tightening their loan standards even for creditworthy borrowers?  The answer goes to the heart of what today’s housing market really needs to recover.  It’s time to break the mortgage lending logjam by de-emphasizing the dominance that the largest commercial banks have taken in the residential mortgage origination market, and give more weight to the institutions that stand ready to lend:  community mortgage bankers who know their borrowers and stand prepared to lend to them.

Mortgage Brokers and Mortgage Bankers

To demonstrate why this is so, begin by considering the basics.  Mortgage bankers close and fund loans arranged by mortgage brokers, and purchase loans originated by other mortgage bankers. Mortgage bankers also often originate loans through their own loan-origination employees, informing applicants about available loan products and working with them through the lending process. In each of these scenarios, mortgage bankers fund the loan transaction with their own funds, or funds they borrow using lines of credit.  Likewise, the mortgage banker is responsible for underwriting the loan and, correspondingly, has a significant financial stake in a loan’s subsequent performance.

It’s an arrangement that has benefitted the housing market for decades.  Unfortunately, in the overheated lending environment that led to the market collapse, the role of the mortgage banker became secondary in the minds of many – consumers and financial professionals – to the role of the mortgage broker.  Brokers are intermediaries between the applicant and mortgage bankers, theoretically giving their customers access to a wide range of loan choices.  Unfortunately, as many fixated on the subprime borrowers and “no doc” loans to applicants with a high credit score, credit quality dried up and the entire mortgage industry, bankers and brokers, were seemingly tarred with the same brush of irresponsible tactics. 

The result was the dropping of a regulatory hammer symbolized by the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act).  It established nationwide continuing education (CE) and testing, and mandated that the states license mortgage loan originators employed by mortgage bankers and brokers; however, mortgage loan originators employed by federally regulated banking institutions were exempted from these requirements. 

The Uneven Playing Field

Mortgage loan originator licensing required by the SAFE Act was intended to weed out the “bad apples” – and rightfully so.  During the past three years just 66% of the loan originators taking the national test for the first time passed; slightly over 80% subsequently pass – obviously, it’s a tough test.  But mortgage loan originators employed by the tier-one national banks are not required to take the test. 

That dominance has been amply documented.  In the first quarter of 2012 the four largest commercial banks with mortgage lending divisions – Wells Fargo, JP Morgan Chase, U.S. Bancorp and Bank of America – accounted for nearly 54% of the residential mortgage market.[3]  Yet these are the same banks that have tightened lending standards and face numerous problems of their own:

  • A $26 billion settlement paid nationwide, as forced by the attorneys general of 49 states, to settle allegations of “robosigning” in home loan foreclosures.
  • A 16-month supply of bank-owned inventory in unsold homes, which is sure to rise as foreclosures that had been on hold are moved ahead in the wake of the state settlements.

And on the horizon, a global regulatory framework, Basel III, calls for the banks to greatly increase their capital reserves at a time when they should be lending.

The Mortgage Banker’s Strengths

This is a market problem that simply shouldn’t exist. It’s a basic fact that in today’s financial marketplace, mortgage lending is profitable.  Interest rates on new U.S.home loans are higher than yields on the mortgage securities they are typically packaged into. The gap between the cost of 30-year loans and benchmark Fannie Mae yields, a measure of lenders’ profit margins called the primary-secondary spread, had widened by early May of 2012 to about 0.96 percentage point, compared with a 10-year low of negative 0.12 percentage point in June 2007, according to data compiled by Bloomberg News. The spread peaked at 1.66 percentage points in December 2008, as conditions were collapsing.[4]

That brings us back to the strengths of the mortgage banker.  Unlike large commercial lenders, independent mortgage banks typically do not have a big backlog of real-estate-owned to sell.  Because they know their communities and borrowers, these lenders are committed to helping close home sales that are at fair market value to benefit the industry and the homeowner.

Mortgage bankers’ financial successes are linked to loan performance, giving them a stake in borrowers’ ongoing ability to repay their loans. Mortgage bankers are financially motivated to make loans that make sense. Mortgage banker revenue can come from multiple revenue streams associated with managing various risks throughout the life of a loan, including the risk that the borrower defaults. Whether they hold loans or sell them to investors, mortgage bankers generally lose money when loans default. As a result, mortgage bankers have a greater interest in ensuring that borrowers choose products that will give them long-term financial success.[5]

This distinction is crucial.  A local mortgage banker has a direct stake in earning income over the life of the mortgage.  The mortgage broker’s incentive lies in upfront fees; the large commercial bank’s incentive lies in earning income on the spread between the yield on mortgage-backed securities and mortgage rates (currently more than twice the norm). Neither of these incentives serves the best interest of the homebuyer, and until the homebuyer receives help at the lender level the market will not recover.

The housing market crisis did not develop overnight, and it will not be solved overnight. Those of us in the financial industry know there is still more to do to restore market confidence.  But the financing foundation for a recovery exists.  Community mortgage bankers should be encouraged to build on that foundation, to benefit the housing industry and the country.

James H. VanSteenhouse is Manager and CEO of InterLinc Mortgage, one of the fastest growing mortgage companies in the industry.  www.interlincmortgage.com

 

[1] Freddie Mac, “Fixed Mortgage Rates Average New All-Time Record Lows” (5/3/12), http://freddiemac.mwnewsroom.com/News

[2] Federal Reserve, “The April 2012 Senior Loan Officer Opinion Survey on Bank Lending Practices,” http://www.federalreserve.gov/boarddocs/SnloanSurvey/201205/default.htm

[3] Bloomberg News, “Wells Fargo Dominates Home Lending” (5/3/12), http://www.bloomberg.com/news/articles/2012-05-03/wells-fargo-dominates-home-lending-as-bofa-retreats-mortgages

[4] Bloomberg News, “WellsFargo Dominates Home Lending.”

[5] See Mortgage Bankers Association of America, Mortgage Bankers and Mortgage Brokers: Distinct Businesses Warranting Distinct Regulation.

COMMENTS

  • by Time4change | 7/3/2012 2:48:51 PM

    The mortgage broker’s incentive lies in upfront fees . . . . soooo, the writer is a mortgage banker. Articles such as this that skew information as fact are not helpful. I am a mortgage broker my incentive lies in (a) satisfied customers (b) repeat customers (c) most importantly my reputation and integrity. It is nauseating to read articles such as this that paint a mortgage broker as grabbing all the up front fees they can. I worked in retail lending (mortgage bankers) most of my career where I witnessed money grubbing first hand. The reason I am a broker now, I don't have to rub elbows with others in my office who grab all the money they can irregardless of the outcome for the consumer.

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