Nothing warms the heart of a mortgage banker (or mortgage broker) more than falling interest rates and a good old-fashioned refinancing boom.

How low are mortgage rates? A consumer with "A" quality credit can now command a 7%, 30-year fixed-rate loan (the most common type of mortgage) with no points. Seven short months ago the best the same customer could do was 8.5%--and just about no one was refinancing.

But at 7%, the residential lending sector is rubbing its hands with glee at the prospect of higher loan volumes and all those nice little fees that go along with a refi boom. As U.S. Banker went to press, the Federal Reserve had unexpectedly cut the federal funds rate by 50 basis points, sparking a much needed stock market rally, and increasing greatly the likelihood that the anticipated residential refi "boomlet" may very well turn into a bonafide "boom."

And what does the mortgage industry have to thank for falling interest rates? The economy, stupid.

Yes, one of the great ironies of mortgage banking is that recessions aren't necessarily bad for all lenders. True, a recession causes unemployment to rise and consumers to feel poor, which means they don't spend money on big-ticket items like houses. But when the economy slows, the Fed cuts rates, and that generally spurs refinancings to increase.

One reason refis are somewhat preferable to "new purchase money" loans (mortgages used to buy a new or existing abode) is that it is generally easier and cheaper to refinance your existing customers than to go out and find new ones. Large mega lender/servicers, including Countrywide, Wells Fargo Home Mortgage, Bank of America Mortgage and so on can refi their existing customers by taking a walk through their own loan files. For instance, they can isolate potential refi customers by running a computer program that spits out the name and telephone number of every customer with a mortgage rate above 7.5%.

Before the Fed cut rates in early January, most mortgage-related economists like David Berson of Fannie Mae were projecting loan production of about $1.1 trillion in 2001. If $1.1 trillion is achieved it will be the fourth-best year ever behind 1998 ($1.55 trillion), 1999 ($1.2 trillion) and 1993 ($1.02 trillion). Now with rates continuing to fall, $1.3 trillion could be a real possibility.

Final figures for 2000 are not yet available, but for the year just ended, production will probably be about $950 billion, clearly disappointing compared to the heady years of 1999 and 1998.

In fact, 2000 was so bad for some residential lenders that they decided to exit the business entirely or at least partially. G.E. Capital Mortgage, based in Cherry Hill, NJ, is a prime example of a firm exiting entirely, while First Union Corp. is a good example of a commercial bank that sold most of its residential servicing rights while retaining the ability to produce loans.

G.E. sold most of its business to the bank-owned Wells Fargo Home Mortgage of Des Moines. Who was the buyer of First Union's mortgage assets? Wells again.

It is no secret that some commercial banks loathe the residential business because of its cyclical nature and the havoc it can create when it comes to earnings. Says one mortgage banker, requesting anonymity: "It's the only business I know where you can earn a lot of money for a year or so, and then give it all back over the next three."

The cyclical nature of mortgages and the ups-and-downs of loan volumes have driven some commercial banks crazy--to the point where they don't originate or service home loans, and instead choose to ignore or outsource that function. Major banks that long ago jettisoned their mortgage companies include Bank of New York, Bankers Trust, First Interstate, Wells Fargo (which later merged with Norwest, getting it back into the mortgage business) and PNC, to name but a few.

And it's not always the fact that the mortgage unit is losing money. Often a mortgage unit might be making money but not enough to justify its existence. Mike McMahon, an analyst with Sandler O'Neill & Partners, notes that the thinking among some bank managers is that the capital used to support a bank-owned mortgage company can be deployed better elsewhere.

But McMahon also points out that banks aren't always the best at timing: "There's a half-dozen or so companies I know that got out of production but kept the servicing, thinking that, 'Oh, this is a nice little revenue stream,'" he says. "But with rates falling they could be in a world of hurt in 2001."

Yes, mortgage banking is also a counter-cyclical business, which means that when production wanes, as it did in 2000, mortgage bankers can live off their servicing income. But when interest rates fall, as they are doing now, production booms and servicing rights disappear as customers refinance with (sometimes) other lenders. No one ever promised that making a living in mortgage banking was easy.

Today, mortgage refinancings account for about 40% to 45% of all new loan applications being filed. This figure, again, was for the last week of December, before the Fed cut rates.

If you look at the past 18 months, mortgage rates on fixed-rate "A" paper conventional product peaked in June of 2000 at 8.55%. Historically speaking, 8.55% is not a bad rate. In 1990 FRM rates were 10.13%, and total production that year was $458 billion. Ouch.

In the record year of 1998, FRM rates averaged 7.02%--which resulted in the aforementioned $1.55 trillion in loan production.

Countrywide Home Loans, the nation's fourth-largest lender, said recently that, even though it has been in business for 32 years, its refi volume hit an all-time low this past summer--not during the Carter years or the 1990-91 recession.

According to company chairman Angelo Mozilo, Countrywide's refi volume as a percentage of total production fell to as low as 5% this past July. Luckily, for Countrywide its purchase money business was strong enough to make up for the lack of refis. Today, refis account for 45% of Countrywide's loans--thanks, again, to falling rates.

Is Countrywide concerned that its servicing rights will get hammered during the anticipated refi boom even though production will blossom? According to Mozilo, not at all. "I think 2001 is going to be a fantastic year for us," he says.

Countrywide is also the nation's fourth-largest servicer, with $280 billion in housing-related receivables on its books. "I'm not worried about servicing run-off," he says. "We're hedged. I'll take a refi boom anytime. We can deal with the run-off."

Paul Muolo is executive editor of National Mortgage News. He can be emailed at:

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