Mortgage Bankers Say Market Risks Contained

The Mortgage Bankers Association announced the release of the white paper, Housing and Mortgage Markets: An Analysis, which was written to “put the flood of commentaries and analyses regarding housing markets and new mortgage products into proper perspective by assessing a broad array of market data, reviewing the risks, and reaching some conclusions.”

Home prices have recently appreciated at an “unusually rapid rate,” with the national appreciation rate reaching 12.5% annually in the first quarter, the paper said — well above the 6% annual rate growth of the past 30 years. But there is dispersion of growth across the country due to positive economic fundamentals including low mortgage rates at the national level and strong employment growth rates at the local level. While most coastal areas have experienced double-digit house price growth in the last year, with many state growth rates above 20%, South and Midwest states grew much below the national rate.

MBA chief economist Doug Duncan sees home price appreciation slowing from double-digit rates down to about 4% in 2006 — with incomes eventually catching up.

And while loan-to-value ratios on first mortgages originated in the second half of 2004 remained within historic norms, borrowers have increasingly turned to the use of piggyback mortgages to avoid mortgage insurance on a high-LTV first mortgage and benefit from tax deductions.

Despite rising rental vacancy rates, investor activity in certain U.S. housing markets, especially in coastal areas has increased — a risky trend given “speculators may be more likely to unload properties at the first sign of a downturn in prices,” MBA said. Short-term, speculative investors present the highest risk.

ARMs in the second half of 2004 made up about 46% of the purchase dollar volume and an additional 17 percent were IO loans, which can be either fixed or adjustable, according to the analysis.

The ARM share across all outstanding first mortgages has gone up to 23% this year from 13 percent in 2002. The growth in ARM activity was in part due to the growth in nonprime loans, which mostly tend to be ARMs, and the popularity of hybrid ARMs, which accounted for about half of all new ARMs in the second half of 2004.

But Fed policy changes have started to cut into ARM share, which has been under 30% for five consecutive weeks, Duncan pointed out. He believes ARM share may fade out as the yield curve shifts and makes the products less economically viable than fixed-rate products. But the economist thinks hybrid ARMs will maintain strength.

As of the first quarter 2005, subprime outstandings have jumped to 12.8% of the nation’s residential mortgage portfolio from 2.4% in 1998. Duncan expects the subprime arena to remain a vital part of the market.

In the second half of 2004, nonprime and Alt-A loans reportedly made up 32% of originations.

The growth in stated-income and no-doc Alt-A loans indicates this lending is extending beyond the intended clientele of time-pressed but creditworthy self-employed borrowers to borrowers who would otherwise not be able to qualify for a loan, MBA said.

The overriding belief that borrowers are too focused on finding a mortgage that has an initial payment that will get them into a property, while ignoring potential payment shocks down the road, seemed to be dismissed by Duncan.

“There are risks, but they are far less than the hyperbole of recent months,” Duncan said in a conference call Tuesday. “House price growth will slow, there will be a flattening in the decline in delinquency and this may have a modest slowing effect on the U.S. economy,” he added.

“We believe risks are contained,” Duncan said.

Lenders create innovative mortgage products that enable a range of consumers to become homeowners, and the report highlighted the increasing popularity of products that expose borrowers to substantial payment shock, including option ARMs, low- and no-doc Alt-A loans and interest-only mortgages.

But of all U.S. homeowners, 35% of households own their homes free and clear, and about 50% have fixed-rate debt only. The remaining 15% are in ARMs — and of these only 7% are interest-rate sensitive, “where we’re not clear of how they’re going to react in a rising interest rate environment.” The other half of ARMs are jumbo, which means the borrowers are high-wealth, high-income or have traditionally used ARMs to finance their homes and therefore risks are well-understood, known and already managed by the market, according to Duncan.

Other factors that mitigate housing and mortgage finance risks include an existing healthy economy, growth in household wealth that has exceeded debt growth, and a strong banking sector and financial market, Duncan said.

He noted that “a great deal of consumer learning” about the mortgage process and products has taken place over the last 15 years through three major refinance waves. “People recognize now that since they, on average, only stay in their homes for roughly seven years, many of the newer products types are more closely aligned with that type of behavior as opposed to the traditional 30-year fixed-rate mortgage.”

Also, “it is very important to recognize that the incentives for managing risks are aligned for the borrower, lender and the investor because both the lender and investor have a stake in the borrower being able to meet the payment,” he said.

The paper concludes that although there are a number of risk factors that should be continuously monitored, the appropriate stance is “one of caution, not of panic.”