In the face of lawsuits, penalties and regulatory actions — mortgage lending guidelines have tightened considerably over the past few years. But with the easy money from refinances potentially drying up, easier lending requirements are likely in the offing.
The Federal Reserve’s quantitative easing strategy has been a boon for bondholders who have seen bond prices rise as yield have fallen to historic lows.
Record-low rates have spurred a wave of refinancing — pushing refinance originations to a level not been seen in nearly a decade.
An abundance of business has deterred mortgage bankers from lending outside the box. From their perspective, why bother with taking risks that can lead to litigation, penalties or repurchases when there is more than enough business without taking such risks.
However, as the Fed’s bond-buying spree comes to a conclusion and inflation begins to emerge — interest rates are likely to abruptly increase.
And just as quickly as mortgage rates rise — mortgage originations are likely to tumble.
Refinances accounted for around $1.4 trillion of the roughly $1.9 trillion in total originations during 2012.
In order to keep up with elevated level of production, mortgage lenders have bolstered their infrastructures and added production staffing.
But as refinance business diminishes in response to a spike in rates, lenders must decide whether to eliminate unnecessary staffing or find more business through other channels.
This was the case when the 2003 refinance wave that generated around $2.6 trillion in refinance production that year slowed the following year.
Many lenders, faced with excess production capacity and insufficient business, elected to move beyond the realm of conforming lending and step into nonprime products such as Alt-A and subprime mortgages.
By expanding the pool of prospective homebuyers, lenders were able to maintain new originations. In many cases, the nonprime business was more profitable for the formerly conforming-only companies.
The downside to the expanded base of borrowers was the housing bubble that popped in 2007 and hobbled the U.S. economy for the next half-decade.
This time around, lenders won’t have nonprime products to migrate to when refinance business freezes up.
While there are some market niches that will appeal to a segment of lenders, most companies will be limited to being more aggressive with their conforming and government lending.
Thus far, lenders have been deterred from taking unnecessary risk on loans originated for Fannie Mae and Freddie Mac because repurchase liability has become such a big problem.
On government lending, mortgagees are facing more aggressive actions by the Department of Housing and Urban Development. In addition, penalties that come to three times the losses suffered by the Federal Housing Administration are another huge deterrent for aggressive FHA lending.
But faced with the potential loss of as much as three-quarters of their originations — some lenders will be forced to rethink how aggressive they must become to maintain an adequate level of production.
In addition, while the penalties on agency lending have been fairly stiff over the past few years, much of those problems were related to legacy loans that were originated before the financial crisis.
Given the tighter agency guidelines currently in place and a thawing housing market, some lenders might start to test the limits of aggressive lending.
Initially this might occur with the elimination of overlays.
But as the competition matches the elimination of overlays, more and more lenders will explore where they can stretch guidelines without creating too much liability.
The secondary market is beginning to show signs of life, with several recent issuances of jumbo mortgage-backed securities. If securitizations continue to expand, lenders will have even more options to help keep business going.
