High house prices in US stifle banks’ mortgage units

    Wells Fargo decided to lay off 638 workers from its home mortgage division last month.

    That might be a distress signal unique to a bank that has been plagued by scandal. In an extraordinary punishment, the Federal Reserve has capped the US bank’s assets in the wake of a its fake accounts scandal, making it harder to add mortgage loans to its balance sheet.

    It might be a common, though banal, cyclical issue across the banking sector: while interest rates were low, homeowners were vigorously requesting refinancings for existing loans. Now they are rising, this flow of demands, and fees, is drying up.

    But there is a more obvious and striking explanation, which contrasts with the roaring US economy and asks more profound questions of all the banks: the housing market is slowing.

    “House price appreciation has been running at four times the long-term average for several years,” says Doug Duncan, chief economist at Fannie Mae, the government-backed mortgage guarantor. “As a result, people are saying, ‘at these prices, and with rates rising, I’ll stay where I am’.”

    The Case-Shiller 20-city home price index surpassed its housing bubble peak in January, and has continued to rise since. But activity has dropped off, as buyers and sellers are in stand-off mode.

    Respondents to a Fannie Mae survey of home purchase sentiment cited high prices as the top reason why it is a good time to sell a home — and the top reason why it is a bad time to buy one.

    The number of existing home sales in July fell 1.5 per cent from the prior year, the fifth month in a row showing a decline, according to the National Association of Realtors.


    This switch in housing sentiment and sales contrasts with the overall economic picture in the US. Consumer confidence is at an 18-year high, growth is strong and unemployment is low. Interest rates are rising, but they remain low by historical standards. US consumers’ debt service payments, relative to their incomes, are at multi-decade lows.

    Yet none of this is enough to overcome the stultifying effect of very high prices, and mortgage lenders are feeling the effects. Applications for new mortgages, excluding refinancings, have been flat for the past year after three years of steady increases, and have come off sharply in the past month, according to the Mortgage Bankers Association (MBA) applications index.

    At Wells Fargo, mortgages already make up more than a third of Wells’ total loan book, giving it the highest exposure to housing of the big US banks.

    But the trend for slowing demand is similar at both Bank of America and JPMorgan Chase, where mortgages account for a fifth of the loan book.

    All three banks generate highly profitable fee revenue by originating and servicing mortgages, which is shrinking. At Wells, non-interest income from mortgage banking fell 28 per cent in the first half of this year. At JPMorgan Chase, it fell almost 40 per cent.

    At the big private companies that specialise in originating and servicing mortgages, such as Quicken Loans and Freedom Mortgage, the impact of the slowdown in new mortgages and refinancings is likely to be greater still.

    Such mortgage lenders have crowded the market. Banks that reined in lending for years after the crisis are back in the market, competing with the non-bank lenders that took their place. In July, Wells Fargo chief executive Timothy Sloan referred to cyclical “overcapacity” in the mortgage industry, and the possibility of rationalisation in the coming quarters.

    Basic economics suggests that the high house prices would encourage more supply, something that could free up the market and revive banks’ fortunes.

    Paradoxically, however, a short-term effect of the strong economy has been lower supply. Seeing few affordable properties to move to, potential sellers are not putting their own homes on the market, according to Mr Duncan.

    And builders of new homes are struggling to find staff and manage higher costs. DR Horton, Lennar and Pulte, three of the largest home builders in the US, all noted high labour-cost inflation in their most recent calls with analysts.

    “There is still a near record level of job openings in the construction sector, adding to pressures on builder costs [as] lumber prices and other costs rise,” said Mike Fratantoni, chief economist at the MBA. “Builders have not been able to keep pace due to the shortage of construction workers.”

    The MBA thinks that total home sales will fall this year, and only grow slightly in 2019, while prices continue to rise at a mid-single digit rate.

    If that turns out to be right, and rates continue to move gradually higher, the mortgage business at Wells and the other big US lenders will continue to be under pressure, and Wells’ announcement of lay-offs may not be the last the industry will see.

    Original content The South Florida Business Journal

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