At the end of March, we penned that the "Bank Sector Is In Peril As Refi Activity Crashes Amid Rising Rates" and since then it has only gotten worse. According to the latest Mortgage Banker Association data, mortgage demand continued to slide and last week mortgage application volumes slumped another 1.9% W/W (and -5.5% Y/Y), despite a modest dip in rates. And while initial purchase applications dropped 2.0%, it was the -1.7% drop in refis (which followed a 4.9% drop the previous week) that was once again the biggest concern, as it plumbed levels not seen since the fall of Lehman, nearly a decade ago.
The reasons for this collapse are all too well-known, and were covered here two weeks ago: with interest rates materially higher than they were a year ago, and lending conditions still relatively tight, there is less incentive for borrowers to refinance. As Diana Olick pointed out, "for those who want to take cash out of their homes, more are now turning to second, home equity loans, rather than refinancing their primary mortgages and subsequently losing their rock-bottom rates."
This picks up on what we said last month, namely that "anyone who could, and would, refinance, already has, while the universe of those who have yet to take advantage of lower rates and are eligible to do so, has collapsed as Black Knight pointed out in its latest mortgage monitor report."
What is peculiar is that the latest weekly drop in mortgage apps, whether purchases or refis, took place as the average interest rate for 30-year fixed-rate conforming mortgages decreased to 4.66% from 4.69%. Which means that potential buyers, who are less sensitive to weekly rate moves, are either not enticed by what they're finding on the market this spring, or, more likely, they can't afford it.
However, as Olick notes, the drop is surprising, given that this is the heart of the spring housing season, and a stronger economy would suggest higher demand. Sentiment for buying, however, has been volatile, falling sharply in February and then bouncing back in March, according to a monthly survey by Fannie Mae.
That, or perhaps the economy is simply not "stronger."
Another potential explanation is that buuyers may have been spooked last week by exceptional volatility in the stock market, due to the potential for a trade war with China. Most likely, however, they are turning away from what has become an extremely pricey housing market, something we covered overnight in "Economists Who Push Inflation Stunned That Rising Home Prices Put Buyers Deeper Into Debt."
And, as Olick adds, when an early spring market is this lean and this expensive, some buyers choose to wait until later in the season, hoping to wait out the crowds and find a better deal. Which is bad news not only for homeowners, but also for the banks, whose refi pipeline - a steady source of income and easy profit - is about to vaporize.
However, while exorbitant prices are bad for homeowners who are unable to afford a home, the collapse in refi activity is murder for banks, whose refi pipeline - a steady source of income and easy profit - is about to vaporize.
Here are some more details from the WSJ: last year, 37% of mortgage-origination volume was because of refinancings, according to industry research group Inside Mortgage Finance. That is the smallest proportion since 1995, and the number of refinancings is widely expected to shrink again this year. In 2012, refinancings were 72% of originations.
While purchase activity has climbed steadily from a post-financial-crisis nadir in 2011, growth in 2017 wasn’t enough to offset a $366 billion decline in refinancing activity. The result: The overall mortgage market fell around 12%, to $1.8 trillion, according to Inside Mortgage Finance.
“The market has just gotten so very competitive because every loan matters,” said Ed Robinson, head of the mortgage business at Fifth Third Bancorp . He added that the bank is contacting homeowners who could be eligible for a refinancing in coming years to help maintain that business, and it is also instructing mortgage-loan officers to focus more on purchases.
We demonstrated this plunge in bank mortgage financing last quarter when we showed the near record low mortgage application activity at America's largest traditional mortgage lender, Wells Fargo.
Non-traditional lenders face even greater peril: Quicken Loans Inc. got about 70% of its mortgage-origination volume last year from refinancings, according to Inside Mortgage Finance—a higher proportion than any other large lender.
Of course, the higher rates rise, the more mortgage applications drop, suggesting that contrary to expectations for a rebound in interest expense as Net Interest Margin rises, bank will be far worse off as a result of rising rates as refi activity grinds to a crawl. Or, as the WSJ explains it, "increased mortgage rates can hamper refinancing activity because many homeowners have rates that are already lower than what lenders can now offer. In other cases, the higher rates cut into the savings a homeowner stands to reap by refinancing a mortgage."
The Mortgage Bankers Association expects nothing short of a bloodbath: it forecasts overall mortgage-purchase volume to grow about 5% in 2018 but refinancing volume to drop 27%.
Here is another example of how higher rates are crushing - not helping - traditional banks: since around the beginning of 2017, Valley National Bancorp , based in Wayne, N.J., has transitioned its mortgage business to 40% refinancing from 90%, said Kevin Chittenden, who runs residential lending. The bank previously relied largely on attracting homeowners through its ads for low-cost refinancings, but has since engaged with outside sales reps who are focused on purchases.
“Refi goes with the rates,” Mr. Chittenden said. “So you definitely don’t want to be too leveraged on refinancings.”
It's about to get worse.
Guy Cecala, chief executive of Inside Mortgage Finance, said he expects some smaller nonbank lenders to sell themselves by the end of the year because of the drop in the refinancing market and mortgage originations overall. Unlike banks, nonbank lenders typically don’t rely on branches or ties to local agents, which are traditional tools for capturing mortgage purchases.
Another risk: the return of subprime borrowers. As the WSJ adds, the waning of the refinancing boom also attracts a different type of homeowner than at the beginning. As mortgage rates go up, the average credit score of refinancings tends to go down, according to industry research.
That is partly because savvy borrowers are the ones who tend to take advantage of low interest rates first. Also, some borrowers who are refinancing now are doing so to get rid of their mortgage insurance: Home prices in many parts of the country are going up, meaning some homeowners are less leveraged even if they have paid down only a small portion of their mortgage.
As for "new" mortgage platforms such as Quicken Loans which face an imminent calamity as their refi platform implodes, Chief Executive Jay Farner said the company is still enjoying demand for both purchases and refinancings, including from homeowners whose decision to refinance is focused less on rates and more on consolidating debt or switching to a shorter-term loan.
But, he added, “You’ve got to be a little bit more strategic about how you market, versus what we saw lenders do in the last few years, which is, ‘Hey, rates are low, you should do something now.’”
* * *
The biggest irony in all of the above, of course, is that there are still those who will claim that higher rates in the "new normal" are good for banks. For the far more unpleasant reality: see a chart of Wells Fargo stock.