Economic Recovery Top - Low Country View by: Cal Haupt

I wrote an OP ED back in December 2011 about the relativity of a recession and the best course of action based on my data supported by 3 recessions.  Now the recovery top view.  http://southeastmortgage.blogspot.com/2011/12/low-country-view-of-recessions-from.html  

As we move into the 8th year of the recovery, a DOW 20116, Commercial Flights Full, Malls Full, Restaurants Full, New Car Dealer Lots Over Flowing, and everyone on your street doing home renovations, everyone should govern their actions by data vs. the euphoric feel of a recovery.

With respect to the Mortgage and Real Estate Industry, I am still confident we are in the 15th month of a 60 – 72 month cycle expansion.  I am confident to the tune of investing millions in a 30,000 sq. ft. operations and life balance center at 3575 Koger Blvd in Duluth.  The growth for the past 15 months is ahead of my projections which provides a large enough sample to proof that my hypothesis is correct.

Now for the Yang to the Real Estate cycle Yin.  The financial markets, various stock markets and other financial derivative instruments, can falter without an impact on the Real Estate Market.  Why?  The primary participants or the 80% of the underlying trades in the above markets are institutions and traders.  When it corrects and it will, the retail consumer in general will not be hit the way they were in the last financial crisis because they are not in the markets as deep as they were in 2008-2009.  As a result, they will be unaltered in their euphoric quest for Real Estate.  Whether their need is trading up, trading down, or new home creation for families this trend has 4-5 years left before a plateau. 

My low country view is we all have to navigate the same rivers in a low tide (2011) that we navigate at high tide (today).  Anyone who has been at the helm of a boat knows rivers can be a mundane transit or a harrowing experience depending on tide and weather.  No matter the size of your boat, the outcome is the same.

 This is relevant in that although there looks like more water and routes to take at high tide, beware that the tide cycle and that route outside the normal river may be mud at a lower tide.   The only constant is the Captain (leadership) must know the tidal pattern and govern voyages based on that data.  Financial Markets are no different.  You just need the tide table. 

Most of the Mortgage Lenders that went out of business in 2008-2009 were all navigating in areas that were not part of the average safe tide and were not paying attention to the data that determines our financial tide table.

My advice to MLOs and other professionals related to the Mortgage Industry is although low score, high LTV, and limited documentation products fit a specific need for a very narrow segment of clients; be careful when a Mortgage Company leads with these unique products.  If they do, be prepared for a change in career. 

The safe river is clearly defined by the regulations and directives of our elected officials.  Fannie, Freddie, FHA, and VA products.  Yes, FHA has some low score parameters and should be ingested carefully given Neighborhood Watch reflects gluttons and common sizes them given low scores correlate to higher default and delinquency.  Prudence dictates moderation and sell to client need which is always a fiduciary's safe path for industry participants and clients at all tides.

 

Cal Haupt

Chairman and Chief Executive Officer

Southeast Mortgage of Georgia, Inc.

www.southeastmortgage.com

770-279-0222

Let's LEARN FROM HISTORY NOT REPEAT HISTORY

I am starting to see more data and articles referencing the rise in subprime mortgages.  The stewards of our Mortgage Industry would do well by having longer memories.  There is a reason prudent risk assessment and the 5 Cs of credit hold true through all economic cycles.

A subprime mortgage is a type of loan granted to individuals with poor credit histories (often below 600), who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages.  “The United States (U.S.) subprime mortgage crisis was a nationwide banking emergency that coincided with the U.S. recession of December 2007 – June 2009.  It was triggered by a large decline in home prices after the collapse of a housing bubble, leading to mortgage delinquencies and foreclosures and the devaluation of housing-related securities. The expansion of household debt was financed with mortgage-backed securities (MBS) and collateralized debt obligations (CDO)” with high concentrations of subprime mortgages “offered attractive rates of return due to the higher interest rates on the mortgages; however, the lower credit quality ultimately caused massive defaults.  While elements of the crisis first became more visible during 2007, several major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.  A proximate cause was the rise in subprime lending. The percentage of lower-quality subprime mortgages originated during a given year rose from the historical 8% or lower range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S.  These two changes were part of a broader trend of lowered lending standards and higher-risk mortgage products.^{”  https://en.wikipedia.org/wiki/Subprime_mortgage_crisis}

The Five Cs of Credit: A method used by lenders to determine the credit worthiness of potential borrowers. The system weighs five characteristics of the borrower, attempting to gauge the chance of default. 

The five Cs of credit are:

Character    - Borrowers reputation and intent to comply with agreement
Capacity      - Debt to income before the new loan and after “Affordability”
Capital         - Down payment and ability to survive periods of loss of income
Collateral     - Mental reminder and commitment to loan by having “skin in the deal”
Conditions   - Risk vs Rate must be acceptable to the Lender to extend the loan

Subprime lending generally disregards the above proven standards for approving loans in return for higher rates and fees. 

The 2007-2008 financial crisis was built on lending from 2002 through 2006.  The 2002 economic data and markets have a strong similarity to what we are starting to see today.  The same players are beginning to emerge under new name plates with the same sales pitch as 2002 hoping time has dulled the industry’s memory.  Their misguided sales pitch "You can close more deals and make more money on the backs of those who could not meet conforming mortgage guidelines.  You can do deals others turned down and win favor from referral sources"  Awesome Competent Service and not creating a default concentration in your referral sources projects is the only way to protect clients and your trusted partners.

How many companies that concentrated in subprime products survived the financial crisis of 2007-2008? 

How many of you reading this lost a job due to your company’s choice to originate subprime loans? 

How many of you had to reinvent yourself due to the company you trusted making this choice? 

How many of you built a successful career at a subprime company only to have your world turned upside down?

Let’s not repeat this pattern……  If your company makes the choice to concentrate in subprime lending, look at the history. 

I am passionate about the Mortgage Lending Industry and feel compelled to remind our industry of 2007-2008.  As stewards of our industry, we should forgo the appearance of easy approvals or unsustainable products just for profit.  We should put our Employees, Shareholders, Clients, and the Stability of our Financial System first.  There is no short cut to success, it is a slow methodical process that builds a solid foundation for growth.  We have a fantastic 5 years ahead of us; however, to sustain it we must be prudent and hold firm to sustainable strategies.

Cal Haupt

Chairman and Chief Executive Officer

Southeast Mortgage of Georgia, Inc.

www.southeastmortgage.com

770-279-0222

Low Mortgage Rates - Prosperity & Diminishing Benefit by Cal Haupt

Low Mortgage Rates - Prosperity & Diminishing Benefit

Quantitative Easing, QE, in its various forms, is an activity that drips monetary policy directives into the economy and builds potency like medicine in your body.  See Definition Below.  When you take a pill, you want immediate results; however, medicine does not work that way.  That is why antibiotics are taken over 5 -6 days to build potency and eliminate its target.  Get impatient and take too much medicine and there are consequences.  With respect to QE, these consequences occur as risk profiles change and rates rise, creating an optimistic mentality in the economy.  If the correct dose of monetary policy is applied, the scenario plays out well for all; however, if too much is applied, a point of diminishing return can occur, slowing the economy to the next recession and or depression.  You need just enough medicine to cure the patient and not create a terminal event.  The issue is there are no directions, the weight of the patient is unknown, and the illness being treated is not clear.  Odds are with an overdose at some point in the next 5 years.

The US economy is still absorbing QE 1–3.  This level of stimulus is historic.  The normal result of a QE 1 is some level of inflation once the economy recovers.  With QE 1-3, inflation is a given at some point. It is a matter of when and how much.  There is no data to correlate the outcome of the current level of stimulus in the economy from QE 1-3.  It will cause home prices to rise, inputs to home construction to rise, and equity markets to rise.  People feel better about life in general when their stock portfolio rises and their homes are more valuable.  As a result of this “happy…happy” time, everyone loses sight of 2008 and buys stock at highs, new homes, vacations, cars etc. which creates the expansion cycle.  In my opinion, we are about to experience one of the best periods we will ever see in the Real Estate Industry.  If QE 1-3 was the correct dose of medicine, this will all play out nicely with little disruption or dislocation.  We will know in a few years as the full effect of QE 1-3 is absorbed by the US economy.

History proves there is a point of diminishing return of lower mortgage rates for Consumers and the Real Estate Industry.

Every 7-8 years everyone – Mortgage Borrowers, Realtors, and General Business – cheers the decline in the rates needed to stimulate the economy out of a slump.  This stimulus is necessary and generally short-lived.

The backlash of low rates is normally tighter credit for borrowers and home builders.  The lower rate environment excludes many participants in two important segments of the Real Estate Industry.  Why does this happen?  In an economic slump, there is a flight to safety and some builders and consumers get caught off guard and experience various levels of financial hardship.  Banks and Secondary Markets all take the same path and tighten credit to protect their balance sheets until a recovery is on the horizon.

While rates remain low, there is a corresponding tighter credit policy. Banks retain their risk adverse posture until there is visibility on a better risk return profile.  Builders and Developers have to seek private money or borrower construction perms to fund projects, thus constraining inventory.  Once banks can earn an acceptable return for risk at higher rates, they will open the gates to their coffers and housing will take off.

Banks and Secondary Markets think a lot like a consumer.  If you were offered .25% for your $5,000 in savings, you are probably indifferent between stashing the money under your mattress or depositing it into your savings account.  In an economic decline, trust is lacking and the mattress looks good.  If you are offered 5% at the bank, you are probably willing to take additional risk for the return and do not want to forgo the interest for the safety of your mattress.  As a result, you put your money to work in the bank’s capital structure.  The same logic is used at Banks.  If rates are low, they prefer to mitigate risk and put it in safe instruments like Treasuries or other instruments with low risk.  When yields are higher, they assume more risk and put their deposits to work which provides the capital to expand the economy further – especially the Real Estate Industry.

The same holds true for consumers.  They will accept higher risk as they feel better about the economy and their income prospects.  Even though rates are higher, consumers tend to buy homes when they are confident.  The same holds true for the stock market.  Most consumers never buy during a correction and tend to buy when highs are reached and euphoria exists in the market.  The current low rates are not stimulating new home buyers; however, as rates rise credit will moderate which stimulates new home purchases from the new entrants to the housing market.  At the same time, Bank’s will adjust their posture and fund builders and developers which will create a surge in inventory.

Economic slumps given time will generally seek an equilibrium in the free market; however, the government usually does not have time to allow a natural solution to occur.  This is what occurred in “The Great Recession”.   As a result of necessity or political pressure, our government engaged in monetary policy initiatives to stimulate the economy. 

Everyone should want rates to normalize and seek their natural higher level based on current economic data points.  It will be great for Consumers, the Mortgage Industry, Real Estate Sales Industry, and Builders / Developers.

Cal Haupt

Chairman and CEO
Southeast Mortgage of Georgia, Inc.
www.southeastmortgage.com

http://en.wikipedia.org/wiki/Quantitative_easing

Quantitative easing (QE) is an unconventional monetary policy used by central banks to stimulate the economy when standard monetary policy has become ineffective.  A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other private institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously increasing the monetary base.   This is distinguished from the more usual policy of buying or selling short-term government bonds in order to keep interbank interest rates at a specified target value.