How Long Can the Good Times Last?

How good are things in the residential finance industry right now? So good that both the mega-lenders and the mortgage insurance cartel have not complained publicly about Fannie Mae or Freddie Mac for several months.

And why should they? During the first half of 2001, residential lenders of all stripes funded a record $858 billion in loans, keeping underwriters, loan officers, mortgage insurers, secondary market buyers, Wall Street, and just about anyone else who plays a role in housing finance busier than Santa Claus at Christmas.

Yes, while the rest of the U.S. economy struggles to keep its collective neck above the recession waterline, both the residential mortgage and housing sectors are humming, thank you very much.

How long it will last is anyone’s guess. But mortgage industry veterans know the golden rule has always been: write every mortgage you can get your hands on, and worry about the slowdown when it comes.

$1.7 Billion? Yowsa!
How good was the first half of 2001 for the nation’s lenders? Try these details on for size:
• Based on the current run-rate of production, U.S. lenders will produce an eye-popping $1.71 trillion in loans this year, eclipsing the record year of 1998, when $1.55 trillion in loans came to pass.
• At least five lenders, and maybe six, will produce more than $100 billion in loans this year. Back in 1998 just one lender, Norwest Mortgage (now called Wells Fargo Home) produced more than $100 billion in loans.
• Among the top-five ranked lenders, the volume gains (compared to the same six-month period last year) varied from 56% to 157%. The laggard among the top five (the one with the meager growth rate of 56%) was Bank of America Mortgage, whose parent bank of similar name, has fallen out-of-love with residential mortgages. (Not only is BofA scaling back, but it is liquidating its entire subprime division, EquiCredit of Jacksonville, Fla.)

The only lender among the top 40 that showed virtually no growth was World Savings of Oakland, a thrift whose strong suit has always been the origination and retention of adjustable-rate loans. In the first half, World (its parent is Golden West Financial) produced $9.3 billion in loans, a 1% gain from the same six months in 2000.But World’s top dogs, the husband and wife team of Herb and Marion Sandler, hardly seem worried. The Sandlers, who are both about 70, have seen interest rate cycles come and go and they hardly seem concerned about the future. At a recent investor conference in Washington, the two were proud and confident and said that despite a slowdown in ARM production, it’s smooth sailing ahead. To boot, World/Golden West earned a record $208 million in the second quarter, receiving a boost, in part, from all the Federal Reserve rate cuts. (The rate cuts helped reduce its borrowing costs.)

Yes, even firms that aren’t seeing stellar growth in their loan production seem to be happy.

How Much Longer Can It Last?
For the time being, all appears rosy for residential finance companies. Then again, anyone who has ever worked in mortgages knows how viciously cyclical mortgage banking can be. Residential loan volumes are booming for two main reasons: low interest rates have sparked a tidal wave of refinancings, and historically low unemployment had made Americans feel secure enough in their jobs to buy homes.

Then again, as U.S. Banker went to press last month, the U.S. unemployment rate spiked to just under 5% and all of a sudden Americans are starting to feel a bit queasy about that catch-all phrase known as “consumer confidence.”

Yet, in mid-September Astoria Federal chairman George Engelke told this magazine that despite the slowdown in the U.S. economy, the purchase money business (loans used to buy a home as opposed to a refi) in his neck of the woods — Long Island and New York City — continued to be strong.

Notes: Market Share is based on estimated loan originations of $878 billion during the first 6 months of 2001. (E) Volume involves estimate. (BC) Firms primarily engaged in subprime lending. (1) WaMu is in the process of buying Dime. (2) HomeSide is for sale. Source: Thomson Financial/Quarterly Data ReportNot only that, but home sales and home prices, on a national scale, have held up. It appears the housing and mortgage markets have been two of the economy’s few bright spots. But again, skeptics wonder how long it can last, especially with corporate layoffs accelerating. It seems that every day a manufacturing or technology giant is announcing layoffs in the thousands. And still, homes continue to sell well in most markets.

Granted, there are signs of softness in certain regions, especially areas where technology firms are headquartered. David Andrukonis, chief credit officer for Freddie Mac, says “Northern California, and parts of Florida and Texas are showing weakness,” but he doesn’t necessarily think this will translate into a decline in home prices, at least not on a national scale. “The rate of home price growth should slow, and in some areas it might slow significantly,” he says.

Notes: Results may vary because some firms would not disclose their servicing volumes. Market share is based on total estimated U.S. housing receivables of $5.320 trillion. (E) Estimate. (BC) Subprime servicing mostly. (1) WaMu is in the process of buying Dime. Deal will close in early 2002. (2) HomeSide is for sale. (3) Represents GNMA servicing only.Source: Thomson Financial/Quarterly Data ReportFor lenders, Realtors, and homebuilders, this is good news, at least for the most part. One key to strong home prices is the supply-and-demand ratio. Thanks to immigration and strong job growth, demand is much stronger than previously anticipated. This appears to be the driving force for the continued prosperity in both housing and mortgages.

The Market Leaders
Who were the top residential producers in the first half? Chase Manhattan Mortgage, Edison, N.J., led the pack with $85.9 billion in mortgages written, followed by Wells Fargo Home Mortgage, Des Moines ($74.3 billion); Washington Mutual, Seattle ($67.9 billion); Countrywide Home Loans, Calabasas, ($56.1 billion); and Bank of America Mortgage ($43.2 billion).

Three of the top five — Chase, Wells and Bank of America —- are owned by commercial banks. WaMu is a thrift and Countrywide recently bought a small OCC-regulated bank in Virginia.

Evidence suggests that banks love the mortgage business. Or do they? One of the great ironies of this market is that while some banks continue to grow their business by leaps and bounds, others have retrenched. Well-known names that have left the mortgage business over the past year or so include Mellon Bank, PNC Bank, and Hudson United in New Jersey. Others have scaled back or are in the throes of scaling back — such as Bank of America.

The chief reason for banks leaving the business is margins. Most of those exiting say the profit margins, especially on conventional lending (loans that are eligible for purchase by Fannie and Freddie) are just too thin. Banks would rather deploy their capital elsewhere. And still, you have mega-lenders such as Wells, Chase and WaMu (granted a thrift) hungry to buy other franchises.Consolidation and Servicing
As reported earlier this year by U.S. Banker, there is a growing belief in some circles that within a few years there may be just five mega-lenders and servicers. Two mortgage executives making this case are Countrywide CEO Angelo Mozilo and WaMu CEO Kerry Killinger. These two shops have different engines of growth. Countrywide prefers to grow de novo with minor acquisitions here and there, and WaMu grows by gobbling up medium to large competitors.
Firms that have been acquired by WaMu over the past 24 months include Bank United, Houston; Fleet Mortgage Group, Columbia, S.C.; PNC Mortgage, Vernon Hills, Ill.; and subprime lender Long Beach Mortgage of California. WaMu currently is in the pro-cess of buying top-ten lender Dime Bancorp and its mortgage subsidiary, North American Mortgage. WaMu, by the end of the first quarter of next year, could have about $600 billion in servicing on its books and the ability to originate $160 billion a year in home loans.

Indeed, WaMu is a giant. But even if WaMu hits the $600 billion mark in servicing, its market share will be just 11%, far short of its stated goal of 20%.

At mid-year, the top five residential servicers, as a group, had a combined market share of 37.31%, including first and second liens. The top five lenders, as a group, had a combined market share of 37.32% in the first half. But the lending market share figure can be deceiving. Why? Because mega-lenders such Chase, Wells and WaMu buy a large portion of their production from other lenders — both small- and medium-sized firms.

In other words, while the servicing side of the residential business continues to consolidate, the origination function, apparently, does not.

What does all of this mean? Well, even though the mort-gage industry is enjoying a record year, the good times will end — some time. This means that lenders, especially the mega-lenders, will have to cut costs when the avalanche of loans slows. In the past, firms that have not cut costs fast enough have faced either a huge decline in earnings, or red ink. The mega lenders — Chase, Wells, WaMu, Countrywide — could find themselves with too much capacity when volumes decline.

When the slowdown comes it likely will be caused by rising interest rates. Rising rates are good for the servicing portfolios of mortgage bankers because this means there is less run-off in the portfolio which translates into more predictable fee income. Balancing production and servicing is key to thriving and surviving in the mortgage business.

The current boom has allowed many originators to rack up huge fee income on the front-end (originations) but there has been trouble on the back end, servicing. Case in point is HomeSide Lending of Florida, which is owned by National Bank of Australia.

HomeSide, which services $187 billion in loans (ranking 6th) overall, recently announced a shocking $2.2 billion in writedowns on the value of its servicing portfolio. What happened? In a nutshell: refis, prepayments, and hedging. HomeSide overpaid for servicing that it had bought on the open market by purchasing closed loans and bulk and flow serving. It also mismanaged some of its hedging positions.

When refis soared more than HomeSide had anticipated, it got walloped. It’s no wonder that NAB would love to sell the unit ASAP. The thought on the minds of many mortgage professionals boils down to this: if it happened to HomeSide it can happen to others, right?

Based in Washington, Paul Muolo is executive editor of National Mortgage News. He can be emailed at paul.muolo@thomsonmedia.com