We are seeing unprecedented events right now. In the last weeks and months, we have seen many companies in the non-conforming mortgage industry experience severe problems. Many have been forced to close their doors or cease funding loans. We are sure this has affected your business in some ways.
Why is this occurring?
In 2005 and 2006 lenders got far too aggressive in their product offerings and relaxed their underwriting standards; therefore, we have seen very high loan delinquencies, high fraud and early pay defaults. Because of this, investors began forcing lenders to repurchase these loans. Mortgage brokers have also been experiencing loan put backs because of fraud or misrepresentation as it relates to inflated income or inflated property values.
With the poor loan performance being experienced, investors have lost confidence in much of the product, thus resulting in a demand for a higher coupon or rate of return for the risks. The non-conforming mortgage product became under priced and too aggressively underwritten. This has caused the loans to be worth far less than before. When lenders originate loans that are valued below par, they are then forced to sell them for big losses. Also, their warehouse lines are “marked to market”. This means that warehouse lenders will only advance a certain percentage of the value of the loan to the lender. As lenders continued to write overly aggressive products at under priced rates, they were not able to obtain enough capital to cover the funding of the loans. When you add this to the repurchases, it becomes a big problem.
The simple explanation is that these companies simply ran out of cash. A lender must be able to originate loans at a profit and have enough cash to fund their loans.
What will happen next?
You should expect to see the following products de-emphasized: High LTV combo loans, no money down purchase loans, stated W2 products, stated income loans, first time homebuyer loans, and low credit score loans with thin credit. The market has experienced over capacity. You will see fewer lenders available to fund loans, more lenders exiting the business, more brokers exiting the business, and more governmental regulation. Hybrid 2-year ARM products will come under scrutiny. There will be a move towards more fixed rate and full doc loans. High LTV stated loans have experienced terrible performance and therefore have become very unpopular in the investor community. Look for these types of loans to decrease.
When will this turn around?
This will only improve when three things occur:
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Loan performance must improve to reasonable loss levels. Sound credit and underwriting must return.
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Loans must be priced properly according to the risks associated with those loss assumptions. Rates will go up.
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The investor community will have to regain confidence in the loans and be willing to buy the bonds at good spreads. This will only happen when loan performance shows improvement over an extended period of time.
What will the market look like after all the fallout?
There will be fewer brokers and fewer lenders. Products will be more traditional. Income will be verified and so will property values. Non-prime rates will be higher and loans will perform much better. The industry needs this “correction” and a return to more responsible lending.