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The Road to 2015: Recovery, Consolidation and Mortgage Production Forecasts

Rick Roque
Jun 20, 2013

By now, the election is old news, the Consumer Financial Protection Bureau (CFPB) is here to stay, and while Bill Clinton said in his inaugural speech in 1996, that “the era of big government is over,” we can safely say that the era of big government is upon us. The indirect policies related to economic growth and federal regulations with the CFPB are the clouds that loom over an already struggling economic recovery. Conservatives and bankers themselves, fail to provide what a non-CFPB and Dodd Frank world would look like to actually alleviate this malaise over the economy. Conservatives in Washington speak furiously about how the CFPB and Dodd-Frank would reformed (e.g. thus, here to stay), but little is actually stated by way of a vision, regarding how it would be reformed and what the impact would be. As a result, many of us in the housing markets have been left scratching our heads wanting to see a difference in vision, but as in all things Washington, the more partisanship there is, the less differences there really are between parties. But more uncertainty looms: And this is the good news … First it was the Fiscal Cliff and now financial “crisis” among us is the sequestration. The sequestration is series of automatic, across-the-board cuts to government agencies, totaling $1.2 trillion over 10 years. The cuts would be split 50-50 between defense and domestic discretionary spending. It's all part of attempts to get a handle on the growth of the U.S. national debt, which exploded upward when the 2007 recession hit and now stands at more than $16 trillion. The sequester has been coming for more than a year, with Congress pushing it back to March 1 as part of the fiscal cliff deal at the end of the last session. By the printing of this issue, we will know if a deal is reached thus saving about 0.5 percent of GDP growth for 2013 or whether or not these automatic cuts have taken place. The challenge is, according to the Congressional Budget Office, GDP growth has been previously forecasted for the United States at a paltry two percent (versus China’s eight percent). Therefore, the lack of fiscal responsibility and partisanship in Washington may cost us a 0.5 percent of our growth. This is meaningful because the housing market makes up approximately 15 percent of the U.S. GDP. How the housing market goes, is how the economy goes.  It is widely understood that the lack of growth in the housing market will remain a significant drag on the economy. Without a robust housing market, the economy will lag and the unemployment rate will remain between 7.5 percent to eight percent. So, while politicians play economic roulette we are trying to support consumers as they attempt to refinance their home or move. There are several positive indicators in our industry. The 2013 real estate housing forecast for next year, remains cautiously optimistic however, a rapid expansion of this market segment isn’t likely until after 2015. Credit qualifying requirements for consumers remain very challenging and with a lagging economy, it will take several years–into 2015 until we experience meaningful growth. This is the opinion of many economists–Kenneth Rosen of U.C. Berkeley and Bill Witte of Indiana University’s Kelley School of Business to name just two, who are both optimistic but offer only “lukewarm” optimism for 2013. Terms like ‘underachieve,’ ‘unambitious’ and ‘unfortunate’ lace the optimism for 2013. And given what the housing market has gone through since 2009, this is good news. The market will continue to grow, albeit slowly, but it will continue to grow out of the recessionary malaise the market has been under given the excess inventory, price of oil, instability in Europe (and now the Middle East) and not to mention the economy that continues to frustrate those looking for employment. “What we expect is more of the same in the coming year,” said panel member Bill Witte, associate professor emeritus of economics. “(But) housing is a bright spot. And the second bright spot is the energy sector. We’ve got oil and gas production booming for shale areas. North Dakota has an unemployment rate of three percent.” This should be a good economic model as to the focus of our public policymakers: If we focus on growing the economy with strong private sector growth, the housing market will quickly grow right along with it. The recent budgetary challenges in Washington will continue to frustrate investor confidence in our economy. All told, economists expect the fiscal cliff to drain approximately $600 billion from the economy. It is for this reason–the high unemployment rate and the challenges with qualifying credit standards will keep the housing market, a renting market for most Americans. As you can see below from the Census Bureau Housing Vacancy Survey (2013), renters dominate new household formation. This is in part the inability for borrowers to be approved for a mortgage or, a lack of confidence that if approved, given the lagging economy, their ability to keep paying their mortgage may be in question should they lose their job. So, along with Washington, the American consumer is in a bit of a fiscal crisis as well. Until investors open up their credit appetite for borrowers with a 620-675 FICO, this will frustrate all of our production levels.                   Some economists bullish on housing recovery Home prices will see steady increases through 2016 starting this year, according to a quarterly survey of more than 100 economists, real estate experts and investment strategists. The survey, conducted by research and consulting firm Pulsenomics LLC on behalf of real estate search and valuation portal Zillow between Aug. 30-Sept. 14, 2012, asked 113 participants to project the path of the S&P/Case-Shiller U.S. National Home Price Index over the next five years. The latest S&P/Case-Shiller Home Price Indices, which include data through June, show national home prices up 1.2 percent from a year ago during the second quarter. All of the markets in the S&P/Case-Shiller 20-city composite posted annual gains for the second month in a row, and all but two—Charlotte and Dallas—posted better annual returns in June compared to May. The results were optimistic who anticipated further home price appreciation and a modest increase through 2016. Economists now forecast home prices will rise 2.3 percent in 2012 from fourth-quarter 2011, and see further cumulative rises of 4.7 percent in 2013, eight percent in 2014, 11.4 percent in 2015, and 15.2 percent in 2016.That's an expected annual growth rate of 2.9 percent between 2012 and 2016, slightly under the 3.6 percent annual growth rate experienced in the pre-bubble years between 1987 and 1999. There was a meaningful spread across economists that ranged from 0.3 percent growth to an optimistic 4.4 percent per year. “This spread in the opinions both reflects the uncertainty and how it isn’t evidenced in the data that a genuine recovery has taken root,” said Stan Humphries, Zillow’s chief economist. It is important to note the growing optimism amidst economists, however, not since 2010, have we seen this number of professionals bullish on our recovery and the housing numbers support this optimism. Real estate and mortgage production by the numbers: 2015-2020 and the tunnel ahead Supporting this optimism is a solid six percent overall construction increase, while pessimists yearn for the “good old days.” For those who have adjusted to the recessionary ‘new normal,’ 2013 will reflect a growing trend. Let’s be honest, however this growth trend is not the surge of the 1990s or the growth experienced in the early 2000 decade. Many economists expect to be at 2005 levels of housing starts (1.3M) around 2016 or beyond. For many in the housing market whose average age is 56-years-old (for mortgage bankers) this is a challenge. For those who are under 50 and with capital, the market will present itself as a strong opportunity to capture market share and grow your business. So if you are 56 or 57, it is time to get in touch with your inner 40-year-old. If you are new to the market or perhaps just relatively young, it is time to think aggressively to take advantage of this opportunity. New housing sales will take several years to reach peak levels to over one million units where it plunged in 2010 to a paltry 250,000 units. This devastating drop seemed both irreparable and traumatic, leaving many builders to either go out of business or to consolidate. With new housing starts at 400,000 units (in September) a rise of 5.7 percent from August, optimism spread across all housing market segments. With inventory of foreclosed properties drying up, there is light at the end of the 2015 tunnel–yes, 2015. But what is a ‘recovery’ in this market? The real question is, what is the ‘new normal?’ From the forecast below, issued by Fannie Mae in January of 2013, we are looking at a production forecast that reflects the following, both for the Mortgage Industry and the Housing Market: ►Continued contraction in refinances—approximately 25 percent in 2013 and another 10 percent to 15 percent in 2014. ►Modest growth in new purchase production—expect this to fully rebound in 2017-2020 to 2006 levels. The main indicator here are new construction starts which is covered below as well. ►Competition for production will become fierce. ►Mortgage consolidation will continue–Another 30 percent of the existing approximately 3,000 mortgage banks will go out of business, be assimilated or be acquired by 2014. Mortgage brokers will suffer given the Qualified Residential Mortgage (QRM) and the three-point rule on compensation beginning in January of 2014. This is expected to further contract brokers by another 30 percent-plus. These two efforts will drive the consolidation further, while the larger and better capitalized firms will grow significantly. ►Non-depository mortgage banks, with a net worth of $15 million-plus will be the real winners in the forecast below. Companies who have a high net worth, the infrastructure, compliance and the right senior leadership in the place, will be highly successful amidst this consolidation. Companies like Residential Financial Corporation out of Columbus, Ohio; Primary Residential Mortgage from Salt Lake City, Utah; Prime Lending from Dallas, Texas; etc., will all be big winners in this market due to their established infrastructure, net worth and leadership. Builders highlight looking to 2013 and beyond As mentioned earlier, rising home prices spiked across the nation. The NAHB naturally joins the chorus of a recovering, albeit slowly economy. “We’re seeing a more robust housing sector than many other parts of the economy,” said NAHB Chief Economist David Crowe. “One of the reasons is we have finally begun to see on a national scale that house prices are picking up again.” Crowe cited a number of other factors that are carrying the housing momentum forward. These include: ►Pent-up household formations ►Rising consumer confidence ►Increasing builder confidence in all three legs of the industry: Remodeling, multifamily and single-family construction; ►Growing rental demand ►More than 100 metros currently on the NAHB/First American Improving Markets Index However, Crowe reiterated the cautionary factors weighing down the housing activity, to name a few: Builders are experiencing difficulties in obtaining production credit; qualified buyers who are unable to obtain mortgage loans, inaccurate appraisals, seriously delinquent mortgages that are at least 90 days late or in foreclosure, and a limited inventory of developed lots in certain markets. The NAHB is forecasting a 21 percent increase in single-family starts this year to 528,000 units and a further 26 percent climb to 665,000 units in 2013. The housing market and the push for new construction, will assist in the overall employment makeup of the country looking toward 2015. Mark Zandi, chief economist for Moody’s Analytics, forecasts that GDP growth will range in the two percent range this year and next and “double that growth closer to four percent in 2014 and 2015.” At the same time, he expects job growth to go from two million per year to closer to three million in 2014 and 2015. “A big part of this optimism is the housing market,” said Zandi. “I expect 1.1 million total housing starts in 2013, 1.7 million to 1.8 million in 2014 and over 1.8 million in 2015.” Fannie Mae agrees with this assessment with their housing forecast–in demand and housing starts (supply) in 2013: While this is the most opportunistic view shared by economists, it is driven by the Federal Reserve’s role in keeping mortgages rates low through 2015 and a very optimistic assumption that banks will take advantage of near zero lending rates from the ‘window’ and turn this around to broadening qualifying requirements. Banks, however are still recovering from losses from the bust, that it is unlikely that this will occur. It is the opinion of this writer that this will diminish Zandi’s forecast marginally, however what it presents is a possible forecast should the right public policy be put in place. With the regulatory landscape changing as much as it is, it is unlikely banks will be interested in reducing margins any time soon in order to wait for more certain business conditions (as opposed to market conditions). Zandi’s root assumption follows that credit will improve as will private mortgage lending which will help improve the job market environment. Whatever happens, one thing for sure is, the housing recovery isn’t growing without a great deal of effort by policy makers, bankers and real estate agencies alike. The kitchen sink and credit scores Just about everything has been thrown at the economy to get it moving. Through new regulations, HARP 1.0, 2.0, various rounds of the Fed policy to reduce interest rates (known as Quantitative Easing), rock-bottom mortgage rates (through 2015) and down payment assistance programs at the state and federal levels, the housing market is still 30 percent of what it was in 2006. This is heavily influenced by 23 million potential workers being unemployed and a drop in household income, personal net worth and an uncertain future for those employed. This is at the heart of both the optimism and malaise to the housing markets. The good news is, the housing market is not a boom, but it is recovering. One area of improvement will be establishing more effective incentives, as previously mentioned to encourage a broader ‘credit net’ for borrowers who have good jobs, but have margin credit. The issue isn’t availability of loan programs, it is the availability of loans programs to those who can qualify for them. Restrictive credit criteria are suppressing home ownership and this could be fixed with a proper understanding of the mortgage/banking industries. Over-regulation or forcing banks to accommodate this is not going to yield the intended results. Forty percent of borrowers cannot get loans since the average consumer has a FICO of a 640 while the average FICO of the closed loan in October was 762. This is a significant disparity between what the market demands–because clearly homeownership is in the best interest of all consumers at proportionate levels of income, versus what the market will offer. The average FICO for FHA loans was approximately a 700 in this time period; still a significant disparity that could provide homeowners an opportunity to be more personally stable which would improve consumer confidence. Despite little hope for improved credit availability clearly this is an issue. If mortgage banks and depository institutions do not act in this direction, it will be yet another imposed upon requirement by state and federal governments. "Credit is not going to get a lot looser. This administration is not pro-homeownership. They are not homeowner advocates, they are renter advocates because their constituency is largely in urban areas, which typically have a high share of renters,” Kenneth Rosen said. This is a powerful and yet true assessment of where the political and economic landscapes collide. The FHA has done an effective job in providing broader opportunities however there are significant fiscal problems at FHA that will require a tax payer bailout to address a $16.3billion deficit. This will require a federal bailout and rather than a private sector solution, the spiral will continue with further Federal oversight and involvement in an already heavily regulated industry. The end of what we knew or a new beginning The U.S. economy has demonstrated numerous signs of improvement in property values, home building and a leveling off of unemployment–at ‘new normal levels,’ but at least it isn’t any worse than it is. Regardless of how terrible it is for this market researcher to say this, in just this way, we are recovering, with some stated challenges on the horizon that can only make economists excited at the increased importance in being the soothsayer of economic growth. The year 2013 could lead to relatively strong job creation in the private sector, auto sales will be strong, home sales will continue to climb back, corporate profits and cash balances will remain high and rates are assured to be low through the next two years–these all paint an optimistic picture. The fiscal cliff, uncertainty in the Middle East (oil), the possible economic collapse of the European Union and the consequences of inevitable tax increases in the future will hang over this optimism. The challenge is economists, business owners and consumers alike just don’t know what 2013 will bring. A break down in the negotiations around the federal budget, could impact the Mortgage Debt Relief Act which will consider mortgage debt forgiven in a short sale, foreclosure or loan modification as taxable income. This will cease the purchase of excess inventory and have a trickle-down effect on already struggling consumers. This will hurt the housing market as it will impact the amount of money consumers have in their pockets, how much it will hurt is uncertain; that is the ongoing theme: Uncertainty. So, is the economic glass half full or empty … we shall see in the coming months. Rick Roque of Menlo Company may be reached by phone at (408) 914-5895 or e-mail [email protected].
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