A Big (And Long) Crash

*A Big (And Long) Crash*
**By George Yacik**

NEW-GeorgeY***I don’t mean to throw a wet blanket on the recent euphoria about the (somewhat) revitalized housing industry, but it seems to me few people in the mortgage business are talking much about the expected sharp drop in originations later this year and next.

****Both the Mortgage Bankers Association and Freddie Mac are predicting a sharp dropoff in mortgage production, mainly due to refinancings, later this year and an even bigger decline in 2014. The MBA, for example, is forecasting a 34% drop in refis in 2013 followed by a 56% decline next year, with total production down to $1.4 trillion this year, down from $1.8 trillion last year, and a further drop to $1.1 trillion in 2014.

****Freddie Mac’s numbers aren’t any better: down to $1.4 trillion in 2013 from $1.6 trillion last year and falling to an even $1 trillion next year. Mortgage refis are expected to fall to just 45% of volume next year, down from 65% this year and 75% in 2012, according to Freddie.

****But according to a long-time research analyst who’s made some early calls about turns in the mortgage business over the past 25 years – and one I know well, since I worked for him for more than 15 years – that decline is just the tip of the iceberg.

****Stu Feldstein is president of SMR Research Corp. in Hackettstown, NJ, which he co-founded back in the mid 1980s. He’s been covering the mortgage business since then; in fact, SMR was the first firm to rank the top players in the business.

****Feldstein is predicting an “historic crash in mortgage production” when interest rates eventually rise, with the originations famine lasting well beyond 2013 and 2014. Indeed, Feldstein says, we may not see another refi boom for eight or 10 more years. In the meantime, we can expect “a much smaller loan market that stays small for a long time.”

****Lenders have been focused the past several years on cleaning up the mess left by the mortgage industry meltdown plus learning to deal with the new more stringent regulatory regime coming. Understandably, they’ve paid very little attention to this coming refi cliff. But they should, SMR says.

****What’s really worrisome about the coming crash in originations is how long it will last, which is unprecedented, Feldstein says.

****“We see as much as 10 years passing without much to write home about for production-oriented lenders once the current refi boom ends,” he writes in SMR’s Mortgage & Home Equity Loans Industry Outlook 2013 report. “It is very likely to be the longest sustained period of modest loan production in modern history, and it looks inevitable,” although he says it’s hard to predict when it will begin, since that pretty much depends on when the Federal Reserve starts to let interest rates rise.

****What’s driving this expected originations dry spell? There are three main reasons, SMR says.

****Feldstein notes that we’ve now been through more than three full years of historically low interest rates, four if you count this year, five if you add 2014. “There has never before been a time when rates were so low for so long,” he notes.

****That has enabled a huge percentage of homeowners to refinance at rates so low they may never refinance again. More than half of U.S. homeowners currently have mortgages below 6%, SMR estimates. And the longer the Fed keeps rates low, the bigger that population will swell, to as many as three out of four homeowners by the end of 2014.

****In the future, mortgage rates would need to come down to below 5% in order to get these people to refinance again. “Based on history, this seems pretty unlikely,” he says.

****The second reason is the change in the term of the average mortgage loan, which has been shortened dramatically.  Super-low rates have led to a “radical increase” in the number of borrowers who have loans less than the traditional 30 years. The 15-year mortgage has become “the loan of choice for more borrowers than at any other time in recent history,” SMR says.

****A third factor is the drop in home prices, which has led to smaller mortgage debts. Combined with the second reason, people will owe less, and the less you owe, the less likely you are to need to refinance.

****Feldstein notes than in previous refi bust cycles, lenders came up with various strategies to soften the blow and keep the origination mills humming, such as lending to subprime borrowers and rolling out interest-only and payment-option mortgages in order to shoe-horn more people into loans.

****But all of these “tricks,” as Feldstein calls them, ended in disaster, as we all know, with record numbers of foreclosures and a collapse in housing prices, not to mention a global financial crisis. As a result, “when the next interest rate up cycle begins, there will be no offsetting production stimulation strategies left,” he says.

****Purchase mortgages may pick up some of the slack, but not nearly enough to make up the difference from lost refis.

****The sum total: “We believe total annual mortgage volume will drop by 50% or more in the coming crash,” SMR estimates.

****There are a couple of silver linings to this scenario, but only if you’re a big servicer or a big home equity lender.

****“The good news in this is that serviced loan prepayment speeds will become a non-issue,” SMR says, “and the change could usher in a huge rebound for home equity lending.” That’s particular good news for the home equity business, which has been living through more than five years of hardship.

****Of course, if President Obama and Congress would agree to create HARP 3.0, which would enable borrowers with mortgages from subprime lenders to refinance through Fannie and Freddie, that would give the refi business a boost for another couple of years.

****ABOUT THIS COLUMN: We are happy to welcome George to the PROGRESS in Lending team. He’s a veteran financial services reporter with vast industry knowledge. In this regular column he’ll reflect on the latest news and industry trends in his own voice, sharing his unique views, which we hope you’ll find to be very “Interesting,” hence the title of this new column, Points Of Interest.

George Yacik has been a financial writer for more than 30 years. After working 12 years at The Bond Buyer and American Banker as a reporter and editor, he joined SMR Research Corp. as a vice president, where he was the lead research analyst and project leader for SMR’s studies on residential mortgages and home equity lending. Since 2008 he has been writing for a variety of mortgage-related and financial publications. George is based in Stratford, CT, and can be reached at gyacik@yahoo.com.