Housing Bubble 2 comes full circle
Mortgage delinquency rates are low as long as home prices are soaring since you can always sell the home and pay off the mortgage, or most of it, and losses for lenders are minimal. Nonbank lenders with complicated corporate structures backed by a mix of PE firms, hedge funds, debt, and IPO monies revel in it. Regulators close their eyes because no one loses money when home prices are soaring. The Fed talks about having “healed” the housing market. And the whole industry is happy.
The show is run by some experienced hands: former executives from Countrywide Financial, which exploded during the Financial Crisis and left behind one of the biggest craters related to mortgages and mortgage backed securities ever. Only this time, they’re even bigger.
PennyMac is the nation’s sixth largest mortgage lender and largest nonbank mortgage lender. Others in that elite club include AmeriHome Mortgage, Stearns Lending, and Impac Mortgage. The LA Times:
All are headquartered in Southern California, the epicenter of the last decade’s subprime lending industry. And all are run by former executives of Countrywide Financial, the once-giant mortgage lender that made tens of billions of dollars in risky loans that contributed to the 2008 financial crisis.
During their heyday in 2005, nonbank lenders, often targeting subprime borrowers, originated 31% of all home mortgages. Then it blew up. From 2009 through 2011, nonbank lenders originated about 10% of all mortgages. But then PE firms stormed into the housing market. In 2012, nonbank lenders originated over 20% of all mortgages, in 2013 nearly 30%, in 2014 about 42%. And it will likely be even higher this year.
That share surpasses the peak prior to the Financial Crisis.
As before the Financial Crisis, they dominate the riskiest end of the housing market, according to the LA Times: “this time, loans insured by the Federal Housing Administration, aimed at first-time and bad-credit buyers. Such lenders now control 64% of the market for FHA and similar Veterans Affairs loans, compared with 18% in 2010.”
Low down payments increase the risks for lenders. Low credit scores also increase risks for lenders. And they coagulate into a toxic mix with high home prices during housing bubbles, such as Housing Bubble 2, which is in full swing.
The FHA allows down payments to be as low as 3.5%, and credit scores to be as low as 580, hence “subprime” borrowers. And these borrowers in many parts of the country, particularly in California, are now paying sky-high prices for very basic homes.
When home prices drop and mortgage payments become a challenge for whatever reason, such as a layoff or a miscalculation from get-go, nothing stops that underwater subprime borrower from not making any more payments and instead living in the home for free until kicked out.
“Those are the loans that are going to default, and those are the defaults we are going to be arguing about 10 years from now,” predicted Wells Fargo CFO John Shrewsberry at a conference in September. “We are not going to do that again,” he said, in reference to Wells Fargo’s decision to stay out of this end of the business.
But when home prices are soaring, as in California, delinquencies are low and don’t matter. They only matter after the bubble bursts. Then prices are deflating and delinquencies are soaring. Last time this happened, it triggered the most majestic bailouts the world has ever seen.
The LA Times:
For now, regulators aren’t worried. Sandra Thompson, a deputy director of the Federal Housing Finance Agency, which oversees government-sponsored mortgage buyers Fannie Mae and Freddie Mac, said nonbank lenders play an important role.
“We want to make sure there is broad liquidity in the mortgage market,” she said. “It gives borrowers options.”
But another regulator isn’t so sanguine about the breakneck growth of these new nonbank lenders: Ginnie Mae, which guarantees FHA and VA loans that are packaged into structured mortgage backed securities, has requested funding for 33 additional regulators. It’s fretting that these nonbank lenders won’t have the reserves to cover any losses.
“Where’s the money going to come from?” wondered Ginnie Mae’s president, Ted Tozer. “We want to make sure everyone’s going to be there when the next downturn comes.”
But the money, like last time, may not be there.
PennyMac was founded in 2008 by former Countrywide executives, including Stanford Kurland, as the LA Times put it, “the second-in-command to Angelo Mozilo, the Countrywide founder who came to symbolize the excesses of the subprime mortgage boom.” Kurland is PennyMac’s Chairman and CEO. The company is backed by BlackRock and hedge fund Highfields Capital Management.
In September 2013, PennyMac went public at $18 a share. Shares closed on Monday at $16.23. It also consists of PennyMac Mortgage Investment Trust, a REIT that invests primarily in residential mortgages and mortgage-backed securities. It went public in 2009 with an IPO price of $20 a share. It closed at $16.64 a share. There are other intricacies.
According to the company, “PennyMac manages private investment funds,” while PennyMac Mortgage Investment Trust is “a tax-efficient vehicle for investing in mortgage-related assets and has a successful track record of raising and deploying cost-effective capital in mortgage-related investments.”
The LA Times describes it this way:
It has a corporate structure that might be difficult for regulators to grasp. The business is two separate-but-related publicly traded companies, one that originates and services mortgages, the other a real estate investment trust that buys mortgages.
And they’re big: PennyMac originated $37 billion in mortgages during the first nine months this year.
Then there’s AmeriHome. Founded in 1988, it was acquired by Aris Mortgage Holding in 2014 from Impac Mortgage Holdings, a lender that almost toppled under its Alt-A mortgages during the Financial Crisis. Aris then started doing business as AmeriHome. James Furash, head of Countrywide’s banking operation until 2007, is CEO of AmeriHome. Clustered under him are other Countrywide executives.
It gets more complicated, with a private equity angle. In 2014, Bermuda-based insurer Athene Holding, home to other Countrywide executives and majority-owned by PE firm Apollo Global Management, acquired a large stake in AmeriHome and announced that it would buy some of its structured mortgage backed securities, in order to chase yield in the Fed-designed zero-yield environment.
Among the hottest products the nonbank lenders now offer are, to use AmeriHomes’ words, “a wider array of non-Agency programs,” including adjustable rate mortgages (ARM), “Non-Agency 5/1 Hybrid ARMs with Interest Only options,” and “AltQM” mortgages.
“AltQM” stands for Alternative to Qualified Mortgages. They’re the new Alt-A mortgages that blew up so spectacularly, after having been considered low-risk. They might exceed debt guidelines. They might come with higher rates, adjustable rates, and interest-only payment periods. And these lenders chase after subprime borrowers who’ve been rejected by banks and think they have no other options.
Even Impac Mortgage, which had cleaned up its ways after the Financial Crisis, is now offering, among other goodies, these “AltQM” mortgages.
Yet as long as home prices continue to rise, nothing matters, not the volume of these mortgages originated by nonbank lenders, not the risks involved, not the share of subprime borrowers, and not the often ludicrously high prices of even basic homes. As in 2006, the mantra reigns that you can’t lose money in real estate – as long as prices rise.
But there are consequences of high home prices – even in San Francisco: one of its “biggest new-housing construction booms in history.” And all this supply is about to flood the market. Read… This Will Bust San Francisco’s Insane Home Price Bubble