 |
 |
|
 |
|||||||||||||||
 |
|||||||
|
 |
As housing slumps, the roof is falling in on the overbuilt mortgage industry By Justin Hibbard Business Week Magazine, JANUARY 9, 2006 Maybe it was the way Alan Greenspan uttered the word "froth" this summer. Or maybe all the doom-and-gloom newspaper articles finally sank in. Whatever the cause, sometime during the last quarter of 2005, the housing boom peaked. Not convinced? The proof is in the paperwork. Applications for purchase mortgages in early November fell below their 2004 level for the first time in six months -- after a 5% drop from September to October, according to the Mortgage Bankers Assn. (MBA). By late December, applications had plunged to June, 2002 levels. The MBA expects mortgage originations to fall by 18.6% in 2006. Suddenly the mortgage industry's lending machine looks like an eight-cylinder engine crammed into a tiny Ford Focus. During the past few years, the industry built up enough capacity to pump out $3 trillion worth of loans a year. Now retrenchment is in the air. As if falling mortgage demand weren't bad enough, changing interest rates during the past year have made loans less profitable. Mortgage lenders make money by borrowing short-term funds at low interest rates and granting long-term loans at higher rates. The trouble is, the spread between short-term and long-term rates is narrowing. In fact, on Dec. 27, the yield of the 10-year Treasury note briefly dipped below that of the two-year Treasury bill; a year ago, about two percentage points separated the two. The smaller the spread between the two rates, the harder it is for lenders to make a profit. A SHRINKING PIE It gets worse. As mortgage demand has slowed, price competition among lenders has heated up. The result of these forces: a shrinking pie of less-profitable loans. In November, tax preparer H&R Block (HRB ) in Kansas City, Mo., blamed a $72 million loss in its fiscal second quarter (since revised to an $86.3 million loss) on a 44% annual drop in pretax income at its mortgage unit. Who stands to lose the most in 2006? It won't be the big, diversified financial companies. When one of their business units slows, others can pick up the slack. Citigroup (C ), for example, is the nation's sixth-largest home lender, yet it derives just 10% of its revenues from sales of home mortgages. Companies that specialize in mortgage lending, however, face tough times. Some have taken steps to diversify in anticipation of declining business. At especially high risk: lenders that have sold lots of mortgages to so-called subprime borrowers with spotty credit records or unstable incomes. Some of these borrowers have escaped default in recent years only by refinancing at higher home values and lower interest rates, reducing their monthly payments and pulling equity out of the home to spend on other things. "If real estate stops going up, the opportunity to refinance because of a higher value is going to go away," says Michael Moskowitz, CEO at mortgage bank Equity Now in New York. "That's going to hurt companies that were doing bad business." Some lenders also face the consequences of the exotic-mortgage binge that has intoxicated borrowers for the past few years. Back when house prices were soaring, interest-only mortgages and so-called option mortgages appealed to cash-strapped but creditworthy borrowers. Those products offer low payments for the first few years of the loan, after which the monthly bill rises. Low interest rates and rapid home-price gains have allowed borrowers to refinance before the high payments came due. But with that possibility starting to fade, more borrowers may default, and fewer borrowers may take out such loans in the first place. Problems with option mortgages are already arising. Higher default rates, funding shortages, and overcapacity will turn some small lenders into cheap acquisition targets. Smart lenders will see the writing on the wall early and sell to improve their efficiency during the coming slow period. Lenders that wait may wind up selling themselves for less than a house in foreclosure. |
|||||
|
|||||||
