To borrow a phrase from Game of Thrones, winter is coming in more ways than just on the calendar.
Winter is coming from mortgage lending too, according to a new report from Kroll Bond Rating Agency.
KBRA’s new report states that 2016 will likely be the peak year for mortgage originations for “years to come,” as a fall in origination volume will occur in 2017 and beyond.
“While 2016 has been an excellent year for the U.S. mortgage industry with almost $2 trillion in new loan originations, we believe that this year is also likely to be the peak in terms of lending volumes for years to come,” KBRA says in its report.
According to KBRA’s report, there are several factors that will impact mortgage origination volumes moving forward, most notably rising interest rates and continued home price appreciation.
Per the latest data from Freddie Mac, mortgage interest rates increased sharply in the wake of the election, recently rising back above 4% for the first time since 2015.
KBRA’s report notes that the increase in interest rates will impact refinances significantly moving forward.
“The impact of rising interest rates and widening credit spreads is a far larger negative influence on prospective mortgage origination volumes than the relatively small increase in the conforming loan limit,” KBRA notes in its report. “Mortgage lending volume is about interest rates first and foremost.”
As noted in the recent forecast from the Mortgage Bankers Association, KBRA expects refinance volumes to fall in 2017 as mortgage interest rates increase.
“In 2017, however, the MBA is projecting a sharp decline in refinancing volumes to just $145 billion in Q1 2017, down from $263 billion in Q4 2016,” KBRA states in its report. “Purchase mortgages are projected by the MBA to rise to $1.1 trillion in 2017, but refinancing volumes will be cut in half for the full year, leading to an overall decline in mortgage origination volumes of 20% next year compared with 2016.”
Dragging down the total origination volume will be refinances, which are directly affected by rising rates.
“With interest rates rising, the economic and financial environment for the U.S. housing market is going to become progressively less hospitable,” KBRA states. “After nearly a decade-long recovery in both HPA and mortgage lending volumes thanks to the Federal Open Market Committee, KBRA believes that the U.S. housing sector is in the process of normalizing—albeit from rate levels that are, in historical terms, still extremely low.”
As KBRA notes, interest rates, despite climbing back above 4%, are nowhere near the levels seen in 2013 and earlier.
“Going back over the past half century starting in the early 1970s, the average 30- year mortgage rate was 8.26%—double current coupon levels,” KBRA’s report states. “The high was 18% in early 1981 and the low 3.31% in November 2012. The standard deviation over those four plus decades was over 3.1%. Yet the recent market moves do represent, in relative terms, a significant change for both issuers operating in the mortgage markets and fixed income investors.”
The increase in the conforming loan limit KBRA references is the recent decision from the Federal Housing Finance Agency to raise the conforming loan limits for Fannie Mae and Freddie Mac for the first time in 10 years.
The KBRA report notes that many observers view this increase as a positive for mortgage originations moving forward, a view that KBRA disagrees with.
“The change in the conforming loan limit is insignificant compared with the double-digit home price appreciation seen over the past decade, especially in high priced markets such as East and West coasts and South Florida,” KBRA says in its report. “Affordability is an issue in all of these markets.”
As KBRA notes, home prices continue to rise, as shown in the most recent data in the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index.
The index, released Tuesday, shows that home prices are now above the all-time highs set in July 2006.
Combining all those factors together will lead to a drop in origination volume, KBRA states.
“Given the regulatory environment and rising trend in interest rates, KBRA believes that lending volumes for both insured depositories and non-bank lenders are likely to fall in 2017 and beyond as relatively lucrative refinancing volumes dry up,” KBRA states in its report.
“This downward trend in mortgage volumes could be a negative factor on earnings in Q4 2016 and beyond for banks and non-banks alike,” KBRA continues.
“Acquiring purchase mortgage customers is a more complex and expensive process than refinancing an existing mortgage,” KBRA adds.
“This is especially true for risk-averse depositories that must deal with both the Consumer Financial Protection Bureau and prudential regulators who are actively discouraging below-prime residential lending and loan servicing by banks,” KBRA concludes. “No amount of prospective regulatory relief or changes in the rules for loan guarantees in Washington can fully offset the dampening effect of rising interest rates on the home finance sector.”