Need more evidence that the recovery in housing is waning? Key indicators such as the Mortgage Bankers Weekly Application Survey are down almost 50 percent from a year ago, and recent earnings results from large banks such as JPMorgan Chase, Citigroup and Wells Fargo confirm that the mortgage market is undergoing significant structural changes unrelated to interest rates or other short-term factors.
Although the improvement in home prices measured on a national basis is likely to slow in 2014, opportunities abound in areas such as non-agency loan originations, distressed assets, and mortgage servicing rights. This goes for commercial banks as well as nonbanks, provided that the skills to manage these businesses in the new regulatory environment are in place. Sure, conventional wisdom says that regimes such as Dodd-Frank and Basel III are going to chase many banks out of the real estate business, but in fact the reality is a good bit more subtle.
In terms of mortgage originations, nonbanks very well may have an edge over banks because of the punitive capital and liquidity rules of Basel III. Most commercial banks will not touch a new 1-4 family mortgage loan with a FICO score below the mid-700s, as these loans generally will require a 50 percent capital risk weight. Non-agency loans will carry capital risk weights twice that for agency-qualified loans held in portfolio, plus Basel III penalties for liquidity.
The changes in risk preferences dictated by Basel III have enormous implications for the mortgage market. Realtors know that their clients are having a tough time getting loans from commercial banks, so this creates a big opportunity for nonbanks willing to work with prime and subprime customers. (Ironically, commercial banks are bidding aggressively for jumbo loans that cannot be agency guaranteed, but these prime loans tend to have low loan-to-value ratios and high borrower FICO scores.)
The punitive capital rules under Basel III also are compelling the largest banks to slowly reduce their footprint in loan servicing; however, bank capital is not the only factor. New federal rules and increased regulatory attention, as well as major industry settlements and changes in state laws, make life very difficult for the largest commercial banks and are resulting in operating losses for affected entities. As a result, nonbanks are making significant inroads in a business traditionally dominated by the largest commercial banks. At the end of September, four of the top 10 loan servicers in the United States were nonbanks, and these firms now account for over $1 trillion in unpaid loan balances.
None of this is to suggest that commercial banks will exit the servicing business completely. Why should they sacrifice the profit they can continue to collect on performing loans?
Instead, what is likely to evolve is a more even distribution of the $9.8 trillion U.S. loan-servicing market. Whereas today Wells Fargo and JPMorgan Chase account for about a third of the total servicing footprint, in the future a greater number of both commercial banks and nonbanks will be involved in the business. This will be better for consumers and for the financial services industry, because the operational risks and rewards of loan servicing will be spread across a greater capital base.
The world of lending and loan servicing is undergoing huge transformation, with operational changes that will take time to play out.
Nonbanks are likely to be net raisers of capital as they grow into greater roles in lending, servicing and related specialties such as distressed servicing, asset management and real estate brokerage. Servicing distressed loans, for example, will likely be addressed by "high touch" nonbank servicers whose operations are optimized to deal with the needs of consumers in financial difficulty.
But commercial banks will remain significant, if not the predominant players, in real estate finance for many years to come.
Christopher Whalen is executive vice president at Carrington Holding Company, a private, nonbank firm focused on selling, financing and managing residential real estate.