Two Mortgage Markets Emerging from the Crisis

by: Judy Weil

Hundreds of mortgage lenders have disappeared, and banks are leery of taking their traditional place again as mortgage lenders. Many homebuilders and banks have noted a marked increase in FHA or government loans taking the place of traditional mortgage lenders for buyers with lower credit scores. High end builder Toll Brothers (NYSE:TOL) has seen a rise in FHA-backed loans, but says it won’t really be impacting its business in the future. Likely because they don't really have lower end buyers.

Perhaps two mortgage markets are emerging from this crisis. Private lenders such as life insurance companies and the finance arms of homebuilders that will only take a chance and lend on the highest FICO score borrowers. In particular, those who are willing, at least in practice, to put 30% down to buy a house. And then there's the government—the only lender who will take a chance on the lower end buyer.

How will the government be able to change those dynamics and stop being the subprime lender when this is all over? It could prove difficult to get private lenders to enter this marketplace again without a permanent government backstop. This is particularly relevant now in the discussion about what to do eventually with GSEs Fannie Mae (FNM) and Freddie Mac (FRE).

From Old Republic International Corp. (NYSE:ORI) Q308 conference call:

MI [mortgage insurance] penetration rates have fallen significantly and the FHA rate has grown I would guess somewhere up to... close to 20% in this market. So, that has greatly reduced the growth in the risk and… will moderate the need for capital in these next few quarters.

Radian Group (NYSE:RDN) noted on its Q308 conference call that it anticipates growth in mortgage insurance with FHA’s increasing market share. However, that could be offset by private lenders writing their own policies. To higher end borrowers only?

Lenders seem to be continuing to expect to put a significant amount of (inaudible) with the more private mortgage insurers. At the same time, especially with trying to refinance out some of the borrowers who have had credit issues, FHA has been gaining some share there.

Quotes from just some of the homebuilders reporting the rise in government-backed loans this quarter:

From Cavalier Homes' (CAV) Q308 conference call:

Q: On the finance side, anybody exiting or increasing activity?

A: We really just have a couple of outlets for chattel and the rest of the stuff is either Fannie, Freddie or FHA… except for local banks which is what a lot of dealers do.

From Ryland Group's (NYSE:RYL) Q308 conference call:

The shift in government insured loans continues as 54% of the loans we originated in the third quarter were FHA or VA. Prime loans accounted for the rest. Our average FICO score was 712, and the average combined loan-to-value was 90%.

From Pulte Homes' (NYSE:PHM) Q308 conference call:

Non-agency funded originations fell from 13% of loans funded from the warehouse line last year to approximately 1% this quarter. Additionally, within the funded agency originations, FHA loans continued to increase as they were approximately 30% of the loans funded from the warehouse line in the third quarter versus approximately 24% in the second quarter of 2008.

From Centex Corp.'s FQ209 conference call:

CTX Mortgage is now solely focused on Centex home buyers and is originating FHA and GSE loans almost exclusively.

KB Homes (NYSE:KBH) said on its FQ308 conference call:

At the end of the third quarter approximately two-thirds of our backlog of sold homes were qualified with an FHA or VA loan.

From D.R. Horton’s (NYSE:DHI) FQ408 conference call:

In the fourth quarter, our company-wide capture rate was approximately 63%, our average FICO score was 710 and our average cumulative loan to value was 92%. Our product mix in the quarter was essentially 100% agency eligible with government loans accounting for 71% of our volume.

Luxury homebuilder Toll Brothers (TOl) appears to be a different story. From its FQ408 conference call:

We see real glimmers of hope on the jumbo market. We just struck a deal with a major bank to supply jumbo financing for some of our condo products… We’re about to we think consummate a deal with a major life insurance company and we see liquidity is coming back into the market.

Low income= government, high income= private. Toll’s finance arm:

On the conforming [loan] side the 5%, hopefully soon to be 4.95%, we can do 95% financing for most buyers. There are some areas where that’s a little constrained in declining markets and that credit score generally would be in the 640 maybe 650 range.

That fits... most of our buyers. On the jumbo side its typically 10% down. Again in declining markets it might be a little bit constrained from there and again credit scores in the 660 to 680 range.

The average delivered credit score right now is 753. Our average LTV is 68.72%.

Q: So people are not putting down 10, they’re putting down 30 you’re saying.

A: Our average LTV for years has been in the 70% range.

Generally it’s the first time homebuyers who are looking for the higher leverage and often they’re also the ones with the lower credit scores. So if you look at some of the entry level condo communities for example, those would be the ones that are looking for that type of financing, and the fact is that FHA is very attractive to those folks because its only 3.5% down and their credit parameters are much more relaxed then those of the MIs [mortgage insurance].

We’re just beginning to do a fair amount of FHA… It helps us move some marginal units to people who couldn’t get in under the current conventional parameters and we’re thrilled to have it but its not something that we think is going to be a major part of our business going forward.