Mortgage Slump Hits Top Thrifts As ARMs Fizzle
The nation's top thrifts, long powerhouses in the home mortgage arena, have fallen into a severe lending slump that shows no signs of abating.
Their main product, the adjustable-rate mortgage, has plunged in popularity as consumers grab bargains on fixed-rate models. And with the economy still weak, home sales continue to fall and lenders have tightened credit standards.
Interest rates are hardly helping matters. Fixed-rate mortgages are sporting their lowest rates since 1978, attracting risk-averse customers who want to lock in the rate for the long term.
The statistics are telling. Among eight major thrifts tracked by Smith Barney, Harris Upham & Co., only Golden West Financial Corp. of Oakland, Calif., has managed to post a gain in lending.
Originations at H.F. Ahmanson & Co., the nation's largest thrift, have dropped 46% in the first seven months of this year. New mortgages are down by 30% at Great Western Financial Corp., the No. 2 player.
A Boom in Fixed-Rate Loans
By contrast, lenders that specialize in fixed-rate loans appear to be doing land-office business. New loans at Countrywide Funding Corp., a Pasadena, Calif., mortgage company, have risen 80% since last year.
If rates on fixed-rate loans continue to stay low - as many economists expect - even the healthiest thrifts may soon experience flat or declining asset growth.
"Some of these guys are looking at the potential of having to change their strategies," said Gary Gordon, and analyst at PaineWebber Inc.
Thrifts Standing Pat
So far, however, the thrifts are generally sticking with the adjustable-rate mortgage, confident that the loans will return to favor when interest rates eventually rise.
The bias toward floating rates is deeply ingrained among thrift industry survivors.
"We know that interest rates will go up and down, and we try not to lose our focus during those low-rate periods when it's tempting to become a fixed-rate lender," said E.S. Lyons, a senior vice president of Beverly Hills, Calif.-based Great Western.
Thrift executives first embraced the adjustable loan 10 years ago to protect themselves against rising interest rates. They learned their lesson a few years earlier when accelerating interest rates drove funding costs well above the yields on fixed-rate mortgage loans at scores of thrifts.
Profit in Adjustables
In recent months, they have increased their fixed-rate lending somewhat, selling the loans into the secondary to avoid rate risk. In this strategy, the thrifts earn fees by funneling monthly payments from homeowners to holders of mortgage-backed securities. But they say that making and holding adjustables is more profitable in the long run.
Waiting out the lull in adjustables is clearly no fun.
"Obviously it bothers you when you're not putting all your work force to its best use," said Richard Deihl, chairman of Los Angeles-based Ahmanson.
"We're most efficient when we're making about $14 billion or $15 billion of loans a year. Now we're doing between $8 billion and $9 billion," he said.
Up to now, profitability has been holding up surprisingly well for the thrifts. That is because the index used to reset adjustable loan rates moves slower than the thrifts' cost of funds. The thrifts have thus locked in handsome net-interest spreads.
Among the major thrifts tracked by Smith Barney, the spread of asset yields over funding costs averaged 291 basis points in July, up from 241 a year earlier. Ahmanson and Great Western have both been posting record net interest income.
However, analysts caution that the spread bonanza may soon come to an end as the crucial index catches up with past declines.
At the same time, asset growth could prove increasingly hard to come by, as consumers continue a trend of refinancing adjustables for the appealing fixed-rate models. With originations flagging, the thrifts may lose more loans than they gain.
A Dual Problem
"Thrifts are facing the double whammy of spread compression and asset shrinkage," said Bruce Harting, an analyst at Salomon Brothers.
Part of the thrifts' problem in originations is the housing market in California, where the big thrifts are based. Sales in August fell by 9.2%, marking the third consecutive month of declines.
In addition, some of the thrifts have been tightening their credit standards. While that has helped curb delinquencies in a time of rising unemployment, it has clearly cut into lending volume.
At Great Western, for example, a pullback from making loans with low downpayments may have reduced total volume by 20%, First Boston Corp. analyst Eric Hemel wrote in a recent report.
The Worst Slump Ever
Adjustable-rate mortgages, meanwhile, are in their longest, deepest slump since they were introduced.
Adjustables accounted for less than one-third of all new mortgages in each of the past 24 months through July, down from an average of 45% in the 1980s, according to the Federal Finance Housing Board.
Right now, adjustable-rate mortgages are being offered at an average starting rate of 6.8%, or 220 basis points below the 9% average for fixed-rate loans. While that spread is fairly large by historical standards, consumers evidently view the savings as insufficient compensation for the risks.
Appeal of Low Rates
Perhaps the most important factor in the decline of adjustables has been the absolute level of rates on fixed-rate mortgages. Many mortgage professionals believe that fixed rates below 10% hold a special psychological appeal to consumers.
Fixed rates, which take their cue from bond yields, have been below 10% for almost all of 1991. Some lenders are now betting that 9% will become the next magic threshold, particularly for refinancing out of adjustables.
But eventually, the thrifts say, rates will turn and their star will shine again. "It's absolutely an interest rate cycle," contends Mr. Deihl of Ahmanson.