Lending Shifting, but Still Tight

The Federal Reserve released its survey of senior loan officers (SLOOS) earlier this week. On its face, the survey suggests a modest loosening of credit for prime and non-traditional lending. However, the picture is a little more mixed for those groups and credit for borrowers with less than pristine credit remains tight.

Respondents to the SLOOS survey indicated an improvement in mortgage lending to prime and non-traditional borrowers. However, lending to subprime borrowers tightened from last quarter.

While respondents indicated a loosening of prime borrowing, this may not represent an expansion of credit to the market as opposed to a shift from FHA backing to conventional backing. As depicted below, the share of mortgages backed by either Fannie Mae or Freddie Mac that had a down payment less than 10% bottomed at 8% in 2010. Rising foreclosures put pressures on private mortgage insurers some of which became illiquid over this period and stopped issuance of new policies as a result. However, this trend reversed course in 2012 before rising sharply in 2013. The excellent performance of loans made in recent years has helped these companies to recapitalize as problematic older loans aged off company books. Furthermore, some companies restructured or received new infusions of capital, while a few new, freshly capitalized companies entered the industry. As a result, private insurers reintroduced support for lower downpayment mortgages and/or reduced pricing for it. Combined with better prospects for the market in 2013, the effect has been an increased willingness of lenders to originate loans for backing by the GSEs since pricing has improved and the counterparty risk from a weak or insolvent mortgage insurer has declined significantly. In short, if a borrower goes into default, the lender can count on the mortgage insurer to cover the cost. This change and improved pricing has shifted originations to the GSEs rather than to the Ginnie Mae which securitizes loans that are insured by the FHA. The shift from the FHA to private MIs helps elligible borrowers as private mortgage insurance rates are significantly lower.

While this shift signals a thaw in originators’ and insurers’ perception of risks, the change does not impact lending down the credit spectrum, so the credit box as a whole remains tight. Recent trends in FICOs and DTIs of purchase mortgages in the conventional market bear out this trend as the average FICO on conventional and FHA purchase originations remain significantly higher than prior to the period of loosened credit standards.

An interesting insight from the SLOOS this quarter is that lenders have become modestly more willing to originate non-traditional mortgages, which includes ALT-A or limited documentation, interest only, ARMs with multiple payment options, longer terms than 30-years or other such features. This is partly a reflection of new specialized entrants into the servicing industry. However, with home prices rising sharply and affordability softening, this might reflect consumers seeking to stretch their dollars. Many of these feastures would fall into the non-QM space, which sadles lenders with significantly more legal liability. It has been argued that few lenders would originate in this space, but it appears that a niche market has developed though its size is not clear. This trend may reflect close relationships between particular originators and specialty services, which would help to mitigate risk through information sharing and high touch with the borrower.

Finally, the SLOOS survey included several special questions this quarter regarding lenders’ willingness to originate in the 2nd quarter of 2013 as compared to the average for the entire period from 2005 to present. In general, lenders are near or slightly more conservative than the midpoint of this period. However, the difference in willingness to lend was notably tighter outside of the large banks, even for originating FHA product which provides a 100% backstop for these originators.

The housing market is on the rebound while the glacial pace of regulatory reform of housing finance is beginning quickening and the mortgage market is beginning to thaw. As a result, private capital is returning in the form of mortgage insurers, but private securitizations remain anemic in number and skewed to pristine borrowers, while lenders remain cautious against oversight and litigation. As rates rise, lenders are likely to push the credit box wider as higher rates and limited refinancing make purchase lending more profitable. However, until then access remains tight.