As constrained as the residential mortgage lending marketplace has been since the industry-wide collapse of 2008, many lenders have been able to enjoy pretty handsome profit margins in the secondary securitization market. Now that the housing market has been in recovery mode for nearly a year and a half, competition is getting tighter and profits from mortgage-backed securities are shrinking.
According to a recent article in Bloomberg Businessweek, profit margins from initial home loan packaging and securitization have fallen by as much as 40 percent. The pricing of mortgage-backed securities on the secondary market are not as appetizing as they were when the United States Federal Reserve announced its commitment to purchase mortgage-backed securities as a means to ameliorate to keep mortgage interest rates low and stimulate the housing market. This commitment is known as the Fed's third round of quantitative easing (QE3), which has been in place since September 2012.
Anxiety Over the End of QE3
For the Big Five mortgage lenders in the U.S., Ally, Bank of America, Citi, JP Morgan Chase, and Wells Fargo, mortgage origination has been a windfall in the post-bailout era. Even with strict lending and tough underwriting, these banks have enjoyed comprehensive government-sponsored home loan guarantees from Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA). On top of these guarantees, competition has been mostly limited within the Big Five, and the Fed has been there to purchase mortgage bonds at premium pricing.
Now that the housing market is in recovery mode and economic sentiment is stronger in the U.S., banks are seeing an imminent stop of QE3 in the horizon. This is coming at a time when the spread between the origination and secondary markets is at approximately 0.92 percent. Back when QE3 started, the spread was at 1.8 percentage points. This drop in profit margins has some lenders worried, particularly since a few among the Big Five added origination staff in 2012 to handle record numbers of refinances.
Competition is Key
This receding profit margins should prove beneficial to first-time home buyers, at least in theory. The mortgage lending industry is once again facing a dwindling pool of borrowers to refinance, and there are not too many first-time home buyers who qualify for mortgages these days. This situation may prompt the Consumer Finance Protection Bureau (CFPB) to take a closer look at the proposed rules for residential mortgage lending. In the meantime, however, mortgage lenders will need to be more competitive in order to capture market share and remain profitable, which means improving customer service, lowering closing costs and offering better rate locks.