| The number of mortgage applications fell to the lowest level in nearly two decades, the Mortgage Bankers Association (MBA) said recently. The Market Composite Index, a measure of mortgage loan application volume, decreased 160 percent on a seasonally adjusted basis from one year earlier. The purchase index decreased 35 percent over the same period to its lowest level since 1995.
“Both purchase and refinance application activity fell,” said Mike Fratantoni, MBA’s chief economist. “Refinance activity continued to slide despite a 30-year fixed rate that was unchanged from the previous week. The refinance index dropped to the lowest level since 2008, continuing the declining trend that we have seen since May 2013.”
The refinance share of mortgage activity decreased to 50 percent of total applications and was at its lowest level since July 2009, according to the MBA. The adjustable-rate mortgage (ARM) share of activity remained unchanged at 8 percent of total applications.
At the same time, profitability is declining. Independent mortgage banks and mortgage subsidiaries of chartered banks made an average profit of $150 on each loan they originated in the fourth quarter of 2013, down from $743 per loan in the third quarter, the MBA reported in its Quarterly Mortgage Bankers Performance Report.
“Fourth-quarter production profits were at their lowest levels since inception of the Performance Report in 2008, driven by study-high costs in a declining mortgage market,” said Marina Walsh, MBA’s vice president of industry analysis. “One consolation was in mortgage servicing, where financial income improved.”
Among the other key findings of the report are:
The average production profit was 9 basis points in the fourth quarter of 2013, compared to 38 basis points in the third quarter.
Average production volume was $367 million per company in the fourth quarter of 2013, down from $391 million per company in the third quarter.
The purchase share of total originations for mortgage bankers increased to 69 percent in the fourth quarter of 2013, up from 67 percent in the third quarter. For the mortgage industry as a whole, MBA estimates the purchase share at 47 percent, down from 49 percent in the third quarter.
ARMs Gaining Strength
In the interest of boosting volumes, many lenders have begun to offer a growing assortment of ARMs to meet various segments of the market. As interest rates have increased and the yield curve has steepened, more borrowers are choosing an ARM instead of a fixed-rate loan, altering a trend that persisted for nearly a decade. Freddie Mac is forecasting that the ARM share of conforming originations will rise to 12 percent this year, up from last year’s nine percent. The shift is especially pronounced in the Jumbo sector. While only about ten percent of Jumbo loans were ARMs in recent years, many lenders are now seeing the share increasing to 25 percent or more.
A shift in originations from refinancings to purchases is another factor driving the increase in ARMs. More than 95 percent of borrowers who refinanced during the refi boom opted for a fixed-rate loan, according to Freddie Mac, but rising rates are cooling the refi market. The purchase market is moving in the direction of ARMs, according to Frank Nothaft, Freddie Mac’s chief economist.
The most popular product is the 5/1 hybrid ARM. In its annual ARM survey, Freddie Mac found that 71 percent of lenders offered the 5/1 product, by far the most prevalent variety. The interest rate differential versus the 30-year fixed is the main reason, according to observers. In the current market, the variance is about 150 basis points. The cost savings for a $200,000 loan is about $175 per month. For a $500,000 jumbo mortgage, the difference is $425 each month.
For a typical portfolio lender, the margin over the cost of funds is about 250 basis points. The Federal Reserve is unlikely to raise the overnight lending rate for another 18 months. When interest rates rise, lenders ought to be slow to increase deposit rates, which should help to preserve that margin. And borrowers have historically rewritten their loans well in advance of their adjustment date, reducing the lender’s interest rate risk.
For lenders unwilling or unable to retain the loans for portfolio, the secondary market offers a “healthy bid.” Due to a lower-than-expected supply in the market, required spreads for mortgage securities have declined considerably, both for fixed-rates and ARMs. As an example, a lender can repackage a group of 5/1 ARMs (3 percent note rate) into a Fannie Mae-guaranteed security, and receive a sale premium of nearly three points. That is well over four points better than Fannie Mae will pay over their whole-loan cash window.
This time around, the appetite for risk among borrowers is much lower. Successful institutions, however, are tailoring ARMs to match borrower preferences, by limiting payment shock or adjusting amortization schedules. If interest rates continue to rise into next year, then customer demand for ARMs should grow further.
Robert B. Segal is president of Atlantic Capital Strategies Inc., an investment advisor located in Bedford. He can be reached at bob@atlanticcapitalstrategies.com.
