3.30.2016 Would Breaking Up Big Banks Spur More Innovation?

If you’re a certain age, you may remember back in 1984 when the legacy Bell Telephone Company — at that time known as AT&T but also affectionately referred to as Ma Bell — was broken up into independent companies by order of the U.S. Justice Department. The breakup led to the modern-day nationwide telecommunications system we have today.

What if something similar were to happen to the biggest banks in the U.S.? This is essentially what two Federal Reserve presidents have recently said they would like to see in order to help foster more innovation in financial services.

Mirroring Telecom

St. Louis Fed President Jim Bullard told CNBC’s “Squawk Box” recently that he believes a breakup of the megabanks could lead to the kinds of innovations in financial services that have happened in telecommunications over the past three decades. In particular, he pointed to the cellphone and smartphone revolutions that have turned telecommunications on its head.

“You broke that thing up and what did you get? You got all the phones we're talking about this morning,” Bullard said on the program (referring to cellphones). “You have more firms. You take off some of the regulation. You let them do whatever the heck they want. You get more innovation,” he added, commenting on what he believes would happen in this type of environment.

The week before Bullard’s comments, Minneapolis Fed President Neel Kashkari told “Squawk Box” he thinks megabanks are still “too big to fail.” He has urged Congress to consider passing laws that would break up the biggest banks or turn them into “utilities” that would have huge cash cushions to keep from failing.

Not Going Far Enough

Bullard does not believe that the banking regulations that have been passed so far as part of Dodd-Frank have solved the problem of “too big to fail” banks. “We had to pass Dodd-Frank,” he said on the program. “But you still have very big firms that are unlikely to innovate into the future.”

Further, Bullard doesn’t believe much thought is being given to future innovation in financial services. “We're writing all these laws, all these detailed things, about exactly what they are doing today without much thought about what they're going to do tomorrow,” he said.

For his part, Bullard supports Kashkari’s efforts to break up the megabanks if it will lead to more financial services innovation. “You've got to think more deeply about this longer term,” he said. “Whatever you think about Dodd-Frank, it's about how you’re going to get the innovation,” such as virtual currencies (like bitcoin) and peer-to-peer lending.

Innovation in the U.S.A.

Finally, Bullard stressed that he would like to see U.S. policymakers and legislators create the kind of competitive and regulatory environment where financial services innovation starts in the United States instead of overseas. He called the banking environments in China and some parts of Europe a “bureaucratic nightmare,” thus giving U.S. banks an opportunity to gain a competitive advantage when it comes to innovation.

We’re interested in hearing from you. What are your thoughts about breaking up the megabanks in order to foster more innovation in financial services? Send me an email at steven@lendtrade.com.

3.28.2016 Securitized Subprime Auto Loan Delinquencies Rise

Securitized subprime auto loans have been making headlines recently as delinquencies and defaults have begun to rise. According to Wells Fargo & Co., delinquencies on securitized subprime auto loans— which are defined as loans made to car buyers with a credit score below 640 — rose to 4.7% in January.

This was the highest level of subprime auto loan delinquencies in six years. In addition, it could be an indication that more of these loans will go into default later this year and next year, said a Wells Fargo analyst.

Unfortunately, the news is even worse on the default side: The Wells Fargo data reveals that the default rate on subprime auto loans rose a full percentage point in January — from 11.3% to 12.3%, also the highest rate in six years.

Volume on the Rise

Subprime auto loans allow low-income individuals with low credit scores to buy vehicles, primarily used cars. The loans feature higher fees and interest rates than traditional car loans to compensate lenders for the additional risk.

Many car buyers are happy to pay more for a subprime auto loan if it puts them behind the wheel. In fact, as many as one out of every four car loans being made is a subprime loan.

There are various theories as to why subprime auto loan performance is worsening, including the so-so employment picture (don’t believe employment is as healthy as the government’s official unemployment statistics indicate) and tepid economic growth rate. In fact, the current economic recovery, if you can call it that, is now officially the weakest post-recession recovery in U.S. history.

Are Concerns Warranted?

Some economists have voiced concerns about these numbers, especially with some big banks and private equity firms investing heavily in subprime auto lenders. While securitized subprime auto loans are structured to absorb a portion of anticipated defaults, there are concerns that cumulative losses could exceed initial estimates due to declining underwriting standards.

However, these numbers need to be put into perspective. For example, the data covers just securitized subprime auto loans, not all subprime auto loans. This excludes a vast swath of the universe of subprime auto loans that are held on banks’ and credit unions’ balance sheets.

Also, the total volume of subprime auto loans makes up a tiny percentage of all consumer debt in the U.S. so these trends should have a relatively muted impact on the overall economy.

Impact on Auto Sales

But that’s not to say that these worrisome trends in subprime auto loans aren’t worth paying attention to. Sales of autos could be impacted if lenders begin tightening auto loan credit standards in order to minimize future losses.

It will be interesting to see in which direction delinquencies and defaults move throughout the rest of this year.

We’re interested in hearing from you. What are your thoughts about the trends in subprime auto loans? Send me an email at steven@lendtrade.com.

3.10.2016 How Is TRID Impacting Private-Label Securitizations?

As we have discussed in a series of articles and a whitepaper, the new mortgage disclosure rule referred to as the TILA-RESPA Integrated Disclosures rule (or TRID for short) that became effective last October has the potential to drastically change the mortgage application and approval process for homebuyers, mortgage lenders and real estate agents.

Unfortunately, it’s already having a negative impact on efforts to revive the private secondary mortgage market. A recently published article in National Mortgage News noted that investors are rejecting loans “at unprecedented rates” because they don’t comply with TRID’s “Know Before You Owe” consumer disclosure rule.

Half of Mortgages Aren’t TRID Compliant

In fact, more than half of all home mortgages currently do not comply with TRID rules due to minor errors, while about 5 percent to 10 percent of mortgages have major TRID errors, according to Fitch Ratings. Only about 25 percent to 30 percent of home mortgages currently being originated are fully TRID compliant, Fitch Ratings estimates.

Separately, Moody’s Investors Service recently reported that about 90 percent of mortgages have some kind of TRID compliance problem.

Given these statistics, investors are balking at purchasing securitized mortgages due to concerns about the hefty fines the CFPB can impose on lenders for TRID noncompliance. These include civil money penalties starting at $5,000 per day and going up to $25,000 per day for reckless violations and a whopping $1 million per day for knowing violations.

According to the National Mortgage News article, investor hesitation to buy securitized mortgages could bog down the issuance of private-label mortgage bonds even more this year. Last year, only $547.2 billion in private mortgage bonds were issued for jumbo, Alt-A and re-securitized mortgages, according to the Securities Industry and Financial Markets Association. In 2007, this number was $1.7 trillion.

A Near-Impossible Task

The article called compliance with TRID rules “a near-impossible task” due to the hundreds of different variables that have to be accounted for on mortgage forms and documents. Therefore, many investors are awaiting further TRID guidance from the CFPB before purchasing loans, or relying on legal counsel to help them decide whether or not to purchase mortgages with TRID violations.

Given that 100 percent TRID compliance could be difficult if not nearly impossible, investors need to decide how comfortable they are purchasing mortgages with some degree of TRID imperfections. Big banks, meanwhile, are concerned about having to repurchase mortgages that don’t meet TRID rules. Lenders do currently have a grace period from Fannie, Freddie and the FHA for technical compliance with TRID, though this doesn’t exempt them from complying eventually.

Most agreements for the sale or securitization of mortgages include “reps and warranties” indicating that the loans comply with all applicable laws and regulations. Any TRID violations, even minor ones, could trigger damages under the agreement that could include repurchase or buyback of the loan. This is one reason why investors are being so cautious.

In the current environment, investors have to determine their own TRID risk tolerance when deciding whether or not to buy home mortgages. But those who insist on pristine loans probably won’t be very active, at least not this year.

We’re interested in hearing from you. What are your thoughts about the impact of TRID on the private secondary mortgage market? Send me an email at steven@lendtrade.com.

3.7.2016 The Long-Term Outlook for Home Ownership vs. Apartment Rentals

The past decade has seen a drastic drop in the number of people who are opting for “the American dream” of home ownership. In 2006, the home ownership rate in the U.S. was 69%, but by 2015 this had dropped to just 63.7% — the lowest rate since 1993.

Not surprisingly, sinking rates of home ownership have led to strong demand for rental apartments, high growth in rental rates and low vacancy rates. If these trends continue as they’re projected to do, they could have a major impact on the homebuilding, mortgage and apartment rental industries in the years to come.

Effects of Changing Demographics

Due to the drop in the home ownership rate over the past decade, there are now 1.7 million more households living in rental units vs. homes that they purchased. Unlike during the years immediately following the recession, this drop in home ownership was not caused primarily by foreclosures but rather by changing demographic trends.

For example, the number of young and minority households in the U.S. is now outpacing the number of older households, and the former are less likely to own a home. Also, it’s projected that those younger than 30 will form more than 20 million new households between 2015 and 2025. Demographic shifts like these are expected increase the number of renter households by more than 4.4 million over the next decade, or 440,000 new renter households annually.

Looking a little further out, it’s projected that more new households will choose to rent instead of buy a home over the next two decades. According to one forecast by the Urban Institute, between 2010 and 2030, there will be five new rental households for every three new home-owning households. Also, the number of rental households during this time is projected to grow by 13 million (or 650,000 annually) while the number of home-owning households is projected to grow by just 9 million (or 450,000 annually).

This would represent an abrupt change from the previous two decades: Between 1990 and 2010, the number of rental households increased by just 8.8 million while the number of home-owning households increased by a whopping 16.1 million.

Despite these trends, most Americans still believe in the American dream of home ownership. In a recent Fannie Mae National Housing Survey, eight out of 10 (82%) people said that home ownership makes more financial sense than renting. Two-thirds (67%) of current renters even felt this way.

Key Economic Assumptions

These projections for future home ownership and renting all hinge on key assumptions about the economy, job and wage growth, student loan debt levels among college graduates, and the ability of young households to afford to buy homes and quality for mortgages.

In an article published by National Real Estate Investor online, the Joint Center states that while the demand for home ownership should pick up as the economy gains steam, “whether mortgage credit will be widely available to satisfy stronger demand remains to be seen.”

It’s worth noting that not everybody is so pessimistic about future rates of home ownership. In the National Real Estate Investor online article, a Fannie Mae director said that steady labor market improvements, nascent income growth and continued aspirations by young adults to own a home make “stability or modest improvement in home ownership rates … plausible.”

We’re interested in hearing from you. What are your thoughts about future home ownership and apartment rentals trends? Send me an email at steven@lendtrade.com.