Mortgage boom raises fears lenders will turn lax

A big commitment to mortgages is paying off for many banks, but a slowdown is looming that could test their discipline.

Low interest rates have fueled demand for home purchases and refinancing, boosting the bottom lines of mortgage-heavy lenders at a time when other businesses have struggled because of the economic malaise tied to the coronavirus pandemic.

Banks such as Comerica in Dallas, Huntington Bancshares in Columbus, Ohio, KeyCorp in Cleveland and Atlantic Union Bankshares in Richmond, Va., have touted the vibrancy of mortgage banking at recent conferences. Many banks are investing in the business by hiring lenders or upgrading digital platforms.

Atlantic Union expects to report a “record” third quarter for mortgage originations, based on volume in July and August, Rob Gorman, the company’s chief financial officer, said at a recent industry conference hosted by Barclays Capital. “We expect that [to] continue. … We’ve got a nice pipeline.”

While lenders are optimistic about the rest of this year, the mortgage market is expected to grow at a slower pace in 2021. And industry observers want mortgage-dependent lenders to start planning for that deceleration, while avoiding an urge to relax underwriting standards.

Mortgages have “been a very strong positive at a time when positives are hard to find,” said Damon Del Monte, an analyst at Keefe, Bruyette & Woods, though he noted that banks that went big into the business more than a decade ago were stung when the housing bubble burst.

“The industry went down that path 12 years ago,” Del Monte said. Lenders “have to properly underwrite.”

Refinance activity will eventually slow down and the purchase market will be dependent on an economic recovery to create jobs and provide security for potential homebuyers. Shifts in regulation could also create risk, industry observers said.

For now, mortgage activity is holding up.

Fannie Mae recently estimated that volume will hit an all-time high of $3.9 trillion this year. Projected refinance volume of $2.4 trillion would double that of year earlier and mark the highest level in 17 years. Rates are still coming down, with Fannie stating that more than two-thirds of current mortgages “have at least a half-percentage point incentive to refinance.”

Single-family building permits rose by 6% in August from a month earlier, and Fannie forecast that sales of new homes would increase by 14% in 2020 from a year earlier, to 777,000 units. Existing-home sales will likely be flat this year largely because of limited supply in some major markets.

Interest rates will likely be low for years to come.

Scott Brown, chief economist at Raymond James, recently noted that 14 of the 17 Federal Reserve policymakers expect no change in rates through 2023. The Mortgage Bankers Association said in a September report home purchase levels should continue to increase in 2021 and 2022, while refinancing will likely taper off.

The pandemic has led more people to leave major urban centers — where dense populations have served as hotbeds for coronavirus infections — and move to suburban markets. A shift from apartments to suburban houses could drive homebuying demand for years, said Russell Hughes, an analyst at the data firm Trepp and a former Bank of America mortgage lender.

“Until rates move back up, there is a lot of wind in the sales” of the mortgage industry, Hughes said. “I just don’t see things slowing down anytime soon unless there’s some serious new shock to the economy.”

Still, some bankers are acknowledging that the current pace of activity is unsustainable.

“We expect volumes to come down … in the months ahead,” Curtis Farmer, president and CEO of Comerica, said during the Barclays conference.

The Mortgage Bankers Association has forecast that overall mortgage volume, which is expected to rise by 8.3% in 2020 from a year earlier, will increase by 4.2% in 2021.

As volume slows, bankers must become more vigilant about vetting borrowers and setting underwriting standards, industry observers said.

While banks have been reporting lower mortgage deferral rates, the potential for significant issues remains a concern. The research team at Piper Sandler noted in a recent report that bank stocks remain under heavy pressure as investors wait “for the shoe to drop" on pandemic-related loan losses.

Shareholders do not want to see banks compromise on terms or structure just to drive mortgage volume, said Stephen Scouten, an analyst at Piper Sandler.

"I think a lot of management teams are relatively optimistic and upbeat right now, but this is such a highly uncertain credit environment,” Scouten said. “I don't think anyone really knows what's going to happen next. So I think we'll see banks stay conservative — we should."