Ending Uncertainty is Prescription for Housing Recovery

Federal Reserve Governor Elizabeth A. Duke told attendees at a break-out session of the National Association of Realtors® (NAR) Midyear Legislative Meetings that she wished she had, as the session title suggested a “Prescription for Housing Recovery.”  “I do see policies that I believe will help reduce the shadow inventory of houses in the foreclosure pipeline,” she said.  “I also see policy actions that could be taken to improve credit availability for potential homebuyers and, in turn, demand for houses.”

Duke briefly recounted the toll that the housing market had taken on homeowners and the nation’s housing stock and some of the signs of recovery such as improving delinquency rates, and declining inventories of unsold and foreclosed homes. 

She said there have also been signs that home prices are stabilizing and even improving.  These modest improvements, she said, can only continue if the demand for homes strengthens or the supply fails to meet the weak demand.  “My Realtor friends,” she said, “have taught me that when inventories of houses for sale reach a level equal to six months of sales, then markets are usually in rough balance. And, indeed, just as the inventory of existing homes for sale nationally has approached six months of sales, we have seen a leveling of prices suggesting that some equilibrium is being achieved, albeit at low levels.”

The national data, of course, masks differences in regional markets.  She pointed to Miami and Phoenix where there is actually an undersupply of homes while delinquencies and foreclosures are still high.  “For me, this calls into question the notion that housing prices cannot stabilize until the foreclosure pipeline is worked off. I believe that this reduction in inventory, even in the face of a steady supply of foreclosed homes, is a result of a sharp contraction in normal homeowner activity and an equally sharp expansion of investor activity”. This could mean that discouraged homeowners have pulled homes off the market or that a significant portion of inventory has been absorbed by investors.

Despite some signs of improvement, demand for owner-occupied housing remains what Duke called “stubbornly tepid.”  One driver of demand is household formation which typically falls during economic downturns but has been especially weak in this cycle, running at three-quarters of the normal rate since 2007.  At the same time some homebuyers are delaying home purchases because of uncertainty, others because they expect prices might fall even further.

Some who would like to buy cannot because they are unable to obtain a mortgage.  She pointed to the Feds most recent Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS)  showing that underwriting standards for residential mortgages tightened steadily from 2007 to 2009, “and they do not appear to have eased much since then.” 

Obviously lenders are trying to correct for the lax and problematic lending standards in the years leading up to the crash, but Duke listed other factors causing the problem.

Lenders apparently lack adequate capacity. Some lenders have gone out of business and others have cut staff at the same time that requirements for documentation have increased and lenders have become more cautious over fear they might have to repurchase loans.  This has increased the processing time for mortgages from about 4 weeks in 20008 to around 6 weeks in 2010.   Of course if lenders were eager to originate mortgages they could increase staff and invest in systems but Duke believes uncertainty is inhibiting these investments.

Uncertainty is impacting lenders in other ways. Turning first to macroeconomic uncertainty, Duke said so long as unemployment remains elevated and further house price declines remain possible, lenders will be cautious in setting their requirements for credit.  The continuing effects on house prices of the large number of underwater mortgages and of the mortgages still in the foreclosure pipeline remain unclear. In one recent survey, house price forecasts for 2012 ranged from a decline of 8 percent to an increase of 5 percent.

House price uncertainty and the high volume of distressed sales make the job of residential appraisers and lenders more difficult.  Appraisers may lean toward the conservative in setting a home’s value and, as long a house prices continue to decline lenders may lean toward more conservative underwriting which, taken together could discourage or even disrupt sales and Duke said she hears of that happening.  

Lenders have tended to be conservative in making some mortgages that are guaranteed by government-sponsored enterprises (GSEs)–loans in which lenders do not bear the credit risk in the event of borrower default–which suggests that issues other than macroeconomic risk are affecting lending decisions.

In the April SLOOS  lenders said they are less likely today to originate loans to borrowers in several different categories than several years ago and when asked why about 80 percent cited the difficulty of obtaining affordable private mortgage insurance.  More than half the respondents cited risks associated with loans becoming delinquent as being at least somewhat important–in particular, higher servicing costs of past due loans or the risk that GSEs would require banks to repurchase or putback delinquent loans, their right when lenders are thought to have misrepresented their riskiness. If lenders perceive that minor errors can result in significant losses from putback loans, they may respond by being more conservative in originating those loans. If technology and data standardization can be used to enhance quality control reviews at the time of purchase rather than after the loans became delinquent, it would allow errors to be corrected much earlier, resulting in better outcomes for taxpayers, borrowers, investors, and lenders.

There is also uncertainty about future standards for delinquency servicing and the associated costs.  This was partially resolved by the $25 billion servicing settlement and the consent orders entered into by 14 large servicers. However these agreements cover only about two-thirds of all mortgages and the new Consumer Financial Protection Bureau (CFPB) has declared it will develop servicing rules for all mortgage loans, The conservator of the GSEs are developing a set of servicing protocols for GSE loans and federal regulators are doing the same for banks they regulate.  Also affecting decisions about investing in servicing are new approaches to servicer compensation under consideration by the FHFA and new international capital standards that change the capital treatment of mortgage servicing rights

Two major areas of uncertainty arise out of regulations being written under the Dodd-Frank Act;  rules that will set requirements for establishing a borrower’s ability to repay a mortgage including a definition of a “qualified mortgage” or QM. Mortgages that meet the definition would be presumed to meet the standards regarding the ability of the borrower to repay.  Regulators are also developing a definition for “qualified residential mortgages,” or QRMs, a subset of QM that would be exempt from risk retention requirements in mortgage loan securitizations. Each one of these rules will affect the costs and liabilities associated with mortgage lending and thus the attractiveness of the mortgage lending business.

Other big uncertainty is the potential role of the government in the mortgage market, especially the future of Fannie Mae and Freddie Mac still unreserved more than three years after they were put into conservatorship.  Private capital might be reluctant to enter the market until their future is settled.  

Duke concluded by returning to the theme of the session, writing a prescription for housing recovery which she said would include resolving uncertainty about the strength of the economic recovery, especially the labor market which is affecting both homeowners’ willingness to buy and lenders willingness to lend. The Federal Reserve remains committed to fostering maximum employment consistent with price stability, which should help reduce some of the macroeconomic uncertainty.

The efforts underway to reduce foreclosures and distressed sales will stabilize home prices and mortgage loan modifications and short sales will cut the homes in the foreclosure pipeline as will reallocating some properties to rental use.  Policy changes that increase opportunities to refinance and neighborhood stabilization efforts are other solutions.   

But, she said, perhaps the most important solution is that policymakers move forward with the difficult decisions that will affect the future of the mortgage market.  She listed the future of the GSEs, how to promote a robust secondary market, the form of crucial regulations, “and it is unlikely that anyone will fully agree with the final decisions that are made. Nevertheless, until these tough decisions are made, uncertainties will continue to hinder access to credit, the evolution of the mortgage finance system, and the ultimate recovery in the housing market. I don’t want to diminish the importance of any individual policy decision, but I do believe that the most important prescription for the housing market is for these decisions to be made and the path for the future of housing finance to be set. It’s time to start choosing that path.

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Condo or Rental, It’s New in Dumbo

The neighborhood under the Manhattan Bridge is seeing a rush of development, with hundreds of rental and condo units in the pipeline.

Chase, Wells Fargo Report Solid Profits, Credit Improvements in Mortgage Portfolios

Two of the nation’s largest banks came in with first quarter earnings above estimates today, due in part to improvements in their respective mortgage portfolios.  Wells Fargo reported record quarterly net income of $4.2 billion on revenue of $21.6 billion and JPMorgan Chase had net income of $5.4 billion on revenue of $27.4 billion. 

Wells Fargo’s revenue was up $1 billion from the fourth quarter of 2011, due the bank said to growth in noninterest income which was also up $1 billion to 10.7 billion driven by increases of $506 million in mortgage banking, $458 million in market sensitive revenue, and $181 million in trust and investment fees.

Mortgage banking noninterest income was $2.9 billion in revenue based on $129 billion of originations compared to $120 billion in the fourth quarter.  The company provided $430 million for mortgage loan repurchase losses compared with $404 million in the fourth quarter.  Net mortgage servicing rights (MSR) resulted in losses of $58 million compared to a $201 million gain in the previous quarter due to a reduction in the value of the MSRs from incorporating a higher discount rate.  The ratio of MSRs to related loans serviced for others was 77 basis points and the average note rate on the servicing portfolio was 5.05 percent.  The unclosed pipeline at the end of the quarter was $79 billion compared to $72 billion at the end of the fourth quarter.

The company had net charge offs during the quarter of $791 million in first mortgage loans and $763 million in junior mortgage liens, 1.39 percent and 3.62 percent of average loans respectively.  In the fourth quarter net charge offs for senior liens were $844 million (1.46 percent) and junior liens were $800 million (3.64 percent.)  Total non-performing assets at the end of the quarter totaled $26.6 billion, up from $26.0 billion and nonaccrual loans increased to $22.0 billion from $21.3 billion “with the increase exclusively tied to industry-wide supervisory guidance pertaining to the junior lien portfolio” in which 1.7 billion of performing junior liens with associated delinquent first liens were reclassified to nonaccrual status in the first quarter.  The bank said this had minimal financial impact as the expected loss content of these loans was already considered in the loan loss allowance.

Wells Fargo’s earnings equaled $0.75 per common share, up 11 percent from the prior quarter.  Bloomberg reported that analysts had expected earnings of $0.73 cents.  The bank also announced it would be increasing its quarterly common stock dividend to $0.22 per share effective with the first quarter.   

Chase’s first quarter net income of $5.38 billion was down from the record $5.56 billion it earned a year earlier.  Income per share however was up to $1.31 per share from $1.28 a year earlier when there were more shares outstanding.  According to Bloomberg, analysts were expecting earnings of $1.17 per share.

Chase reported that its first quarter results included $1.8 billion in pretax benefits from reduced loan loss reserves related to mortgages and credit cards.  The company also reported $1.1 billion pretax benefit from the Washington Mutual bankruptcy settlement and $2.5 billion in pretax expenses for additional litigation reserves primarily related to mortgage-related matters.

Chase’s real estate portfolio generated net income of $518 million compared to a net loss of $162 million a year earlier, primarily from improving credit trends reflected in the provision for credit losses.  Net revenue was 1.1 billion, down 7 percent from the previous year because of a decline in net interest income from lower loan balances due to portfolio runoff.

The provision for credit losses reflected a benefit of $192 million compared to 2.2 billion a year earlier reflecting lower charge-offs and a $1 billion reduction in loan loss allowances as delinquency trends improved. 

Home equity net charge-offs were $542 million (2.85 percent net charge-off rate) compared with $720 million (3.36 net charge-off rate) in Q1 2011.  Subprime mortgage net charge-offs were down to $130 million (5.51 percent) from $186 million (6.8 percent); prime mortgage charge-offs including option ARMS were $131 million (1.21 percent) compared with $151 million (1.32 percent). 

Nonaccrual loans totaled $7.0 billion, unchanged from a year earlier and up from $5.9 billion in the fourth quarter due to the reporting of $1.6 billion in performing junior liens as non-accruing under the same supervisory guidance that impacted Wells Fargo.

There was net income of $461 million from mortgage production and servicing compared to a net loss of $1.1 billion a year earlier.  Mortgage production generated $1.6 billion in revenue, an 80 percent increase from the prior year, partly from the impact of the Home Affordable Refinance Programs (HARP).  Production expenses increased $149 million to $573 million reflecting higher volumes and a “strategic shift” to the Retail channel including branches where origination costs and margins are traditionally higher.    Repurchase losses were down from $420 million to $302 million. 

Mortgage servicing related revenue was $1.2 billion, down 5 percent from the previous year because of fewer third party loans serviced and expense declined by $175 million to $1.2 billion.  Servicing had a pretax loss of $160 million compared to a loss of $1.9 billion a year earlier.

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February Housing Scorecard Spotlights Chicago

The Departments of Housing and Urban Development (HUD) and Treasury released the February edition of the Obama Administration’s Housing Scorecard on Friday.  The Scorecard is essentially a summary of data on housing and housing finance released by public and private sources over the previous month and/or quarter.  Most of the data such as new and existing home sales, permits and starts, mortgage originations, and various house price evaluations have been previously covered by MND. 

As an overview, the report says that the data for February shows “some promising signs of stability” although the overall outlook is mixed and there is continued fragility in home prices.  Mortgage delinquencies are still declining and are well below the levels of a year ago.  Sales of existing homes have started out the year at the strongest levels since 2007.

There has been some progress with the housing overhang.  The supply of homes on the market continued to decline in February and there is now a 6.1 month supply at the current rate of sales.  The inventory of new homes is even lower at 5.6 months, the lowest since 2006.  However, despite existing home sales reaching the highest level since May 2010, home prices changed little from the previous month, marking a fifth month of seasonal lows. 

HUD Assistant Secretary Raphael Bostic said of the scorecard, “The data this month show that we’re making important progress in providing relief to homeowners under the Obama Administration’s programs. With fewer borrowers falling behind on their mortgages and some 425,000 families taking advantage of our enhanced Home Affordable Refinance Program – standing to save on average $2,500 per year – it’s clear that the Administration’s efforts continue to provide significant positive benefits.  But 1 in 5 Americans still owes more than their home is worth. That’s why the Administration’s recent proposals are critical to promoting healing in the market. Our efforts to ramp up economic development in fragile neighborhoods and to expand homeowner access to low-interest refinance options reflect our commitment to turning these markets towards growth. That is why we are asking the Congress to approve the President’s housing proposals so that more homeowners can receive assistance.”

Each month the Scorecard spotlights a different housing market and the current edition focuses on market strength in Chicago, Illinois and its surrounding communities. The Chicago metro area was one of the hardest hit areas in the nation following the housing market downturn and HUD says the Administration has been active in trying to stabilize the market.  Its efforts, the Scorecard says, have helped more than 220,000 families in the area avoid foreclosure. 

Sales of bank-owned properties and short sales remain high at 35 percent of sales in the market compared to 29 percent nationally which leads to continued weakness in local prices.  Foreclosure processing takes an average of 575 days so properties stay in the pipeline 50 percent longer on average than in other cities.

Illinois has received more than $400 million through the Hardest Hit Fund and approximately $265 million has been awarded to 12 jurisdictions through the Neighborhood Stabilization Program to help purchase or redevelop residential properties and address the effects of abandoned and foreclosed housing. Both programs have helped provide stability to the Chicago housing market.

The Housing Scorecard usually incorporates by reference the monthly report of the Home Affordable Modification Program (HAMP) and related remediation programs.  That report however is now issued bi-monthly and not yet available for February.  

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February Foreclosure Activity Trends Down after January Surge

After a sharp increase in January, foreclosure starts and sales have reverse direction and resumed the steady decline they began in mid-fall.  The February Mortgage Monitor Report published by Lender Processing Servicers (LPS) showed foreclosure starts down 15 percent from January to 172,602, 15.4 percent lower than during the same period in 2011.  Foreclosure sales decreased 19 percent from January to a total of 74,229. Foreclosure sales were down 22 percent in judicial states compared to January and 19 percent in non-judicial states.

The national delinquency rate in February was 7.57 percent, down 5.0 percent from the 7.97 rate in January and 14.0 percent lower than in February 2011 when it was 8.80.  The seriously delinquent loan rate was 7.58 percent compared to 7.69 percent and 8.24 percent during the two earlier periods.

LPS says that while the January increase in foreclosure sales was most pronounced in loans held in bank portfolios, the drop in February was across all investor classes.  Both the increase in January and the reversal in February were closely tied to GSE performance.

Despite the broad-based February improvement, national pipeline ratios continue to decline off their peaks but the changes vary sharply by geography.   At the end of February the average pipeline ratio in judicial states was 84 months as compared to 33 months in non-judicial states.  The ratios are highest in the Northeast, notably in New York and New Jersey where the average pipelines are 846 months and 772 months respectively.

The foreclosure inventory stands at 4.13 percent nationally, 0.5 percent lower than January and 0.3 percent below February 2011 figures but again there are sharp differences between judicial and non-judicial states.  In Judicial states the rate is 6.52 percent and climbing; in non-judicial states the rate is 2.43 percent and trending down.

New mortgage originations remain depressed, continuing a four-month decline.  Origination data for January shows a decrease to 450,000 originations compared to over 500,000 in November 2011.

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