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Fannie economist: Mortgage market faces turbulence

A recent Fannie Mae survey suggests that senior executives at mortgage companies are taking a dimmer view on the outlook for profitability and the demand for home loans. Doug Duncan, Fannie’s chief economist, discusses why lenders are growing more pessimistic.

What are the main reasons that lenders have soured on the outlook this year?

dougduncanWell, we have had a very long period of policy-induced refinance activity. The change in the posture of the Federal Reserve and the growth in the economy is pushing rates up. Of course, refinances are heavily dependent on what the borrower’s current mortgage rate is. As rates have been rising, all those people who locked in low interest rates, they are not moving anywhere. And so, refinance volume has dropped off significantly.

What that means is that the industry has more capacity than there is demand to fill that capacity. The first thing they [lenders] tend to do is start to compete more vigorously with one another, even to the point of not being able to cover their fixed costs, as long as they can cover variable costs in the short run. In other words, [they are] losing money to see if they can survive in that kind of an environment.

Home-purchase activity is flat to slightly down going into this year. That is more a function of the lack of available supply. People who have been traditionally moving up, are staying in place; a lot of them, because they have locked in an interest rate of 3.5 percent or 4 percent. They are not going to give that up with interest rates going up.

And some of it is just demographics. The boomers, who are aging, have said all along that they intend to age in place, and they are. They are spending money on remodeling their homes and staying in place. So, the existing home-supply is at 30-year lows. Those things are putting a real squeeze on lenders. We ask them what is the source of the difficulty. In each case, in the last couple of surveys, it has been competition from other lenders.

Do you think the fierce competition will translate into an easing of credit?

We have seen in the non-GSE [government-sponsored enterprise] area — that is, loans that are not conventional, conforming or government loans — there is some evidence of easing credit conditions in those markets. In the GSE spaces and FHA [Federal Housing Administration] and VA [Veterans Affairs] space, they will go to the edge of the credit box. In other words, they will take any loan that fits within the rules that have been established for underwriting there, but they will not go beyond that. They may make loans that are not eligible for either the government programs or the GSEs. There has been some pickup in private label issuance, but it is not huge.

Do you expect more layoffs from mortgage companies?  

I do. This has been about the fourth or fifth economic cycle since I have been in the real estate space. The typical cycle is that when volumes start to fall off, that reveals excess capacity. Then, since it is expensive to lay people off and rehire them, people will take the pain for maybe six months or so, and then they can’t do it anymore. Then you start to see layoffs. If you look at the employment data in the mortgage industry, it has been flat now for several months. You are starting to see anecdotes of companies laying people off. It is not just that we are conjecturing it. Firms are making some announcements. It is also the case that you are starting to see more mergers. Some of those have been announced publicly. That is also typical in the down phase of the cycle.

The Fed just raised interest rates again. How many more times do you believe they will pull the trigger this year, and how high will mortgage rates go?

We have, at present, [forecast] only one more rate increase in the market. One person [among Fed policymakers] changed their dot plot, which shifted the odds to there being a second rate increase. If we get two quarters of 4 percent growth, there is no question you will get that fourth rate increase [in 2018]. Right now, we do expect a bit more upward pressure on rates. The curve is fairly flat [a situation where there is little difference between short-term and long-term rates]. We don’t expect much of a change in mortgage rates by the end of the year relative to where they are today. Even out into next year, we have a fairly flat profile for the mortgage rates.

So, basically, 5 percent for the 30-year fixed mortgage by the end of this year?

Yes, or into next year.

Looking at the economy and the housing market, do you see any reason for optimism?

The question for housing in general has two parts. Can builders ramp up construction faster than they are? I think they would if they could. Homebuilding will continue to grow gradually. On the existing-home side, it takes people willing to move. Our consumer survey suggests that there is a resilient conservatism among households, supported by this lock-in effect, of having locked in low, long-term rates and not giving them up.

If we do get, as we think, growth in the second quarter that looks something like 4 percent annualized, that means incomes will be growing, employment will be growing. That suggests that demand is growing faster than supply, which continues to put upward pressure on house prices. When you combine that with upward pressure on rates, it creates some affordability issues. On the purchase side, there will be growth in the opportunity to make purchase mortgages, and they will be at a higher dollar volumes. On average, because prices are going up, if [lenders] are in that space, you will be OK.


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