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How Will Lenders Adjust to Tight Housing Supply and Higher Rates?

Posted by Val Srinivas, Banking & Securities research leader, on June 18, 2013

Things are looking up for housing.  Buyer demand is strengthening, prices are rising, and credit conditions are improving.  All in all, many of these housing trends are looking quite positive, as the June 2013 Deloitte Center for Financial Services U.S. Residential Mortgage Market Update (RMMU).

What might be less clear is how lenders will adapt to the new market conditions.  In fact, trends in two crucial drivers of origination volume — housing supply and interest rates — could present short-term difficulties for originators.

Tight supply dampens prospects for growth in purchase origination

Buyers have absorbed much of the market’s excess inventory, leaving few houses on the market. The supply of new single-family homes has been cut in half since 2011, from more than eight months of supply in February 2011 to nearly four months in March 2013. Inventory of existing home sales has followed a similar pattern (Figure 1).

Figure 1: Housing inventory – New single-family homes and existing homes

All else equal, limited supply means fewer purchases — and fewer originations.  And that could mean banks may not see hoped-for, short-term growth in origination volume from such demand.  The picture is one of strong demand and a market caught flat-footed. However, builders have taken note, and housing starts surpassed the one million mark for the first time since 2008. 

Rising interest rates spark the end of the refinancing boom

Looking further ahead, future increases in interest rates may hurt origination activity. Of course, rates remain near historic lows.  But they have little room to fall further. With the Fed likely to start winding down monetary stimulus in the near future, rates may be due for an uptick.

Low rates over the last few years have encouraged many consumers to refinance their loans. But this refinancing boom appears to be petering out. When rates rise, refinancings are likely to decline, perhaps steeply — especially given that many who wished to refinance will already have done so.  As Figure 2 shows, the Mortgage Bankers Association predicts refinancing volume will fall to a third of its current level by 1Q 2014.[1]

Figure 2: Mortgage originations (1-4 family, $ billions)

Large-scale refinancing volume has helped to drive origination profit for several years now, but these projections indicate originators will be hard-pressed in coming quarters to maintain this pace.  Indeed, the impact of declining refinancing volume is already being seen in Q1 financial results reported by major originators.

Nor can originators look to purchase loans for relief.  Supply constraints, a large number of cash purchases[2],  and continuing weakness in other sectors of the economy probably mean weak prospects across the board for the near future.   

Looking to the long run

Short supply and rising rates are likely to create headwinds in the near term, especially for institutions that recently have depended on increased origination volume to drive profitability.  

But the longer-run outlook for mortgage originators is likely more positive.  If the past is any guide, supply will catch up to demand as builders and homeowners adjust to the changing market. Lenders will not remain passive in the face of declining refinancing volumes; they will make changes to standards and strategy in an effort to fill the gap with increased purchase loans.  And across the board, an increasingly vital housing market will eventually boost originator’s bottom lines. 

Originators may also benefit from the increased regulatory clarity given by the recent qualified mortgage and ability-to-repay rule 

as well as the forthcoming qualified residential mortgage rule, which governs securitization and risk retention.  In preparing for renewed challenges in the near term, originators should find hope in their long-term prospects. 

What do you think? How will lenders adapt? What enhanced operational and cost efficiencies are taking place now?

[1] Mortgage Bankers Association, Mortgage Finance Forecast, April 18, 2013.
[2] National Association of REALTORS. “REALTORS Confidence Index.” March 21, 2013.

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