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The October 2005 Federal
Reserve Survey on Bank Lending Practices shows that most banks still
haven't altered lending standards for home equity lines of credit even after
the FED raised concerns about whether lenders were adequately weighing risks.
The report shows domestic commercial banks reported a further net easing of
lending standards and terms over the past three months.
In response to the special question about changes in terms on mortgage loans
to purchase homes, notable net fractions of domestic institutions reported
that over the past two years they had eased a number of terms, including the
maximum size of primary and second mortgages, spreads of mortgage rates over
an appropriate market base rate, and the maximum loan-to-value ratio.
Here are some highlights of the survey:
- Nearly 10 percent of respondents, on net, reported having eased their credit
standards on loans to large and middle-market firms.
- About 30 percent of domestic respondents reported that they had reduced
the costs of credit lines in October.
- Almost all domestic banks that reported having eased their lending standards
and terms in the October survey cited more-aggressive competition from other
banks or nonbank lenders as an important reason for doing so
- Almost 40 percent of domestic banks, on net, reported that over the past
two years they had increased the maximum size of primary mortgages they were
willing to provide.
- About 30 percent, on net, indicated that over the same period they had
increased the maximum size of second mortgages.
According to CFC
October 2005 Operational Results, it seems that Countrywide Financial
is one of the purveyors of the yet still looser bank lending practices that
the regulators are talking about. Here are the highlights:
- Adjustable-rate loan fundings for the month were $23 billion, up 42 percent
from October 2004. Year-to-date adjustable-rate fundings totaled $214 billion.
- Nonprime loan fundings totaled $3.9 billion in October, which compares
to $3.3 billion for the same period last year. Year-to-date nonprime fundings
were $36 billion.
- Pay-option fundings for the month were $8.5 billion, as compared to $3.4
billion in October 2004.
- Interest-only loan volume was $8.9 billion for the month of October 2005,
which compares to $5.9 billion, for the same period a year ago.
The most amazing of those statistics is the rampant increase of "pay-option
loans" smack in the face of flattening or declining home prices and a FED that
seems bound and determined to break the housing bubble by hiking interest rates.
The LA Times recently discussed The
hidden perils of pay-option loans. Let's take a look.
Borrowers with dangerous adjustable rate mortgages that give them the option
of paying just about any way they like may find the loans even more perilous
- and more expensive - than they ever imagined.
For starters, borrowers may find that as the rates on their mortgages adjust,
they could be paying as many as three or four percentage points more than
they would had they chosen a different type of adjustable mortgage.
Perhaps even worse, once borrowers realize they acted unwisely, they may
not be able to get out of their loans without paying a hefty penalty. Even
if you sell your house, you could be required to pay a prepayment fee totaling
six months' interest to terminate the mortgage.
In exchange for all this, the broker who put his client in this precarious
position is getting paid three times as much as he would had he placed the
borrower in a more consumer-friendly adjustable mortgage.
Typically, lenders who actually fund the mortgage pay brokers a half-point
- 0.5% of the loan balance - when they bring in borrowers who want a so-called
payment-option ARM. But if the loan carries a prepayment penalty, they'll
pay the broker a larger incentive.
These kinds of extreme charges are not attached to any mortgage other than
pay-option ARMs, a loan that allows the borrower to choose from four different
payment options each month.
Borrowers can pay the absolute minimum as calculated by a complicated formula.
They can make an interest-only payment based on the fully indexed rate but
with nothing going toward the outstanding balance. Or they can make a full
interest and principal payment based on either a 15- or 30-year payment schedule.
Borrowers are drawn to pay-option ARMs because of their 1% start rate. But
what they often don't realize - and sometimes aren't being told - is that
while their payment doesn't change for a year, the rate starts adjusting
after the first 30 days.
Of course, with these loans, the payment doesn't change until after 12 months.
But because the rate moves on a monthly basis, the result is what's known
as "negative amortization." That means that whatever the difference between
what you pay and what you owe is added to the loan balance.
For pushing such an unfriendly loan on uninformed borrowers, mortgage brokers
are paid handsomely, as are loan reps who work for lenders themselves.
"The kind of stuff going on out there is wrong," says Mitch Ohlbaum, a West
Hollywood mortgage broker. "I think these loans work well when explained
and priced properly. The problem is that no one is educating borrowers on
what they are getting into."
A regular person with a regular job will fall behind very quickly if he
makes interest-only payments. "People who know what they make each month
have no business in a loan like this. They will get demolished."
Mish, is that what this is all about: greed on behalf of the lender and stupidity
on behalf of the borrower? That seems likely but it really is impossible to
say. Perhaps it is more like stupidity on behalf of both the lender and borrower
to be taking risks like this at the pinnacle of this bubble in the face of
repeated FED warnings. At any rate please remember the excuse the lemmings
gave in the survey before they followed each other off the cliff: "Almost
all domestic banks that reported having eased their lending standards and terms
in the October survey cited more-aggressive competition from other banks or
nonbank lenders as an important reason for doing so."
What this most assuredly boils down to is:
- Fear of losing a deal
- Desire to increase market share or "make the numbers" regardless of risk
- Plain out and out greed
- Belief that Greenspan (or Bernanke) will bail them out if anything goes
wrong
Mish, how rampant is this nonsense? That is a good question and enquiring
readers might make note of the fact that in bubble areas such as California,
28% of new mortgages in the first half of 2005 were subprime vs. 5% in 2000.
42% of first time buyers made no down payment on their home, and over a third
devoted at least 33% of the incomes to mortgage payment.
It seems like this is starting to matter right now, but even if not, it is
going to matter sooner rather than later. Much sooner in fact, as evidenced
by this chart.
Some time within the next year 60% of all of the outstanding subprime adjustable
loans are going to reset. This is going to be a rude awakening to many who
will see monthly mortgage payments skyrocket. Worse yet, given rising inventories
and falling or stagnant home prices it is going to be hard to sell.
Right now it does not seem to matter. That is the way it always is. Nothing
matters until it matters, and the corollary is that it never matters until
the bitter end. Right now it seems that the fat lady is singing but few hear
the tune.
Mish, Saxon Capital just reported, what did they have to say?
That is a good question so let's take a look.
Saxon
Capital, Inc. Reports Third Quarter 2005 Operating Results .
"During the third quarter, we continued to see the unfavorable market conditions
that we discussed in the second quarter", said Michael L. Sawyer, Chief Executive
Officer of Saxon. "The continued rise in short-term interest rates, and accelerated
prepayment speeds, coupled with the extended period of muted market pricing
increases continue to adversely effect our results. We remain committed to
prudent management through these times, concentrating on reducing general
and administrative expenses, growing our centralized retail origination platform,
focusing on capital preservation, and ensuring a strong balance sheet."
Well so much for honesty as the following chart shows.
Is Saxon being punished for honesty while CFC is taking on more risk?
Unfortunately I have no answer to that question other than perhaps CFC's day
of reckoning is coming.
Mish readers might recall that we previously discussed Saxon Capital in Are
we headed for a "credit derivatives event"?
In their last conference call Saxon was saying:
- "At the point in time WHEN the credit event comes, AND IT WILL we will
be very well placed to take advantage of what happens next"
- "I am concerned about the level of capital" of our competitors "to service
the bonds as those portfolios age"
It seems to me, based on the above chart, that the market is more worried
about a "Credit Event" at Saxon than its competitors.
Meanwhile, from The Economist Global Agenda, Buttonwood is asking With
a pfffffffft or a fizzle?
What could give this scenario an uglier twist is the sharp increase in funny
loans to funny borrowers over the past few years. "Subprime lending" to people
who would not normally be able to make the grade is running at about $500
billion a year. Much of it takes the form of variable-rate, interest-only
and negative-amortisation loans. Both debtors and creditors are now more
exposed to interest-rate changes.
Banks have been happy to lend to marginal debtors, safe in the knowledge
that they could unload many of the loans either on one of the quasi-governmental
housing agencies (Fannie Mae, Freddie Mac) or to private investors in asset-backed
securities. Many of these loans end up in collateralised debt obligations
(CDOs, which slice up bundles of referenced loans into tranches of different
riskiness for different investors). Japanese and European investors have
been especially enthusiastic buyers of this sort of paper, but there are
signs of battle fatigue now: spreads have widened sharply over the past couple
of weeks.
Indeed. Hot potato is the name of the game.
Take what you can when you can and pass the trash if you can.
Can this go on forever?
Not likely if the following headline is the start of any kind of trend:
Swiss
pension fund shifting away from U.S.
Switzerland 's $15.5 billion state pension fund plans to reduce its investment
in U.S. bonds and dollar-denominated debt because of concern that rising
U.S. government debt and interest rates may hurt the U.S. economy.
Higher market interest rates could lead to defaults on loans by homeowners
and affect mortgage finance companies including Fannie Mae and Freddie Mac,
Eric Breval, managing director of the Swiss pension fund, said during a recent
interview in Geneva. Assets will be shifted into euro-denominated bonds,
he said.
U.S. government debt stands at a record, and Congress has increased its
scrutiny of Fannie Mae and Freddie Mac amid concern that their debt may be
too large, posing risks for the economy. Together, the two companies own
or guarantee almost half of the $7.6 trillion U.S. mortgage market.
"There is a greater risk in the U.S. than elsewhere," Breval said. "When
you see some institutions such as Fannie Mae and Freddie Mac and the time
bomb they are sitting on, something may happen there one day, and we want
to be less exposed."
Fannie Mae is a "time bomb".
I couldn't have said that better myself.
But the party continues. Right now money is still flowing into stocks and the
market seems bound and determined to have a year end party. Who am I to argue?
All I can say is that it will be one hell of a hangover when the party ends.
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