Bruce Norris is joined again this week by Cary Pearce. Cary is the production manager for Provident Bank Mortgage. They do about $20 million in volume a month. He has been with them for four and a half years and has been in the industry for 28 years.
They had just begun the discussion about the reigning in of loan limits. What is interesting about this is that it is at a time where we just had a 25% increase in median price. The loan balances are shrinking, and the median price is increasing. At some point there is going to be a hole in the market where we will be back to the 2004-2006 era where the funding of the standard loans or qualified mortgages will not be anywhere close to the median price. It could be at 60% of the median price.
FHA loan at the end of 2013 were changed pretty radically for California as well as the rest of the country. Bruce wanted to know the impact this may have had on Cary’s business. Cary said the biggest drop they have seen was Riverside and San Bernardino County. Prior to the change, they were able to do a $500,000 loan amount in those counties. With the change, it dropped to 350-355. This is a pretty significant drop. In just a year they had a 30% price increase and a 30% loan balance decline. The last thing Cary saw showed the average home price at around 307, although he does not know how accurate this is. His average loan amount is only about 240; so he does not think too many of his clients would have been affected in Riverside, at least not the FHA buyers. Where you see people who will have a problem are in cities such as Chino and Alta Loma where you had a lot of people doing the high-balance FHA loans who will not be able to do it any longer.
Bruce also asked about if he had a foreclosure occur in 2010 what his chance would be of getting a Fannie Mae loan in 2014. Cary said Fannie Mae requires 7 years on foreclosure. This is really where the big difference is. With FHA it went from 3 years to 1 year. Bruce asked if he had a foreclosure four years ago, Fannie and Freddie are off the table, and he needs to borrow $500 grand in Riverside, then what would his choices be? The answer is he would not have any because FHA is at 355, and their standard limit is three years on a foreclosure. They have the program that came out where if you could prove you had a 20% drop in your income, they would consider you for less than that three-year time span.
However, you have to be able to document it, and this is a loan that has to go manual underwrite. Not too many people fit this criteria. It sounded a lot better when it was actually implemented; it was not functional nor taking a lot of people down to the one-year. Most of the people who let their homes go did it just because they were upside-down since they had a drop in income. Apparently there is no reason to expect that the 7 years is going to change any time soon. FHA is still 3 years, although there are some exceptions on conventional for short sales. For example, if you had a short sale two years ago and had 25% to put down, you can get a Fannie Mae loan right now. Bruce wondered if this is more aggressive than it was a year ago, to which Cary said it is not and is actually the same. Cary said these guidelines were changed within the last 3-4 years where they loosened up a little for the people with short sales.
Regarding FHA loan limits, there was a ratio in the past where they were a certain percentage of Fannie and Freddie’s loan limits. Now you have an FHA loan limit go from 500 to the mid 3s in Riverside. Bruce asked if they are done cutting this or if it is an annual event now until we get back in line with ratios of the past. It has always been an annual event with FHA, Fannie, and Freddie as far as loan limits go. They reevaluate every year based on median home price, and this is how they come up with their limits. This year median home prices exploded, and the loan balance declined. Bruce wondered if that evaluation is outside of the normal scope now in saying you are now determined to lower the number regardless of median price. Cary said one of the problems was FHA’s volume got so heavy that they were doing way more loans than they wanted to do.
Back in 1998 the 80/20 loans became very popular. Back then the FHA volume fell to negligible amounts at about 1-2% of production. It should typically be at least 30-40% of the volume. This did not turn out to be too healthy either. There were a lot of problems with the 80/20 loan itself that lead to the crash. Bruce asked Cary if he had heard advertisements from other lenders who he thought were repeating themselves again. Cary said he does not think we will see the same problems going forward only because everything has cooled off and we have the QM kicking in that will not allow the stated incomes or interest only. It will be difficult going forward because those creative financing products will not be there.
Bruce asked why they would not be there if they are profitable. There were some stated income loans that made perfect sense and performed very well. They were a very high-performing product, but they are going to have to repeal QM for those things to come back. Either this or they will have to be funded outside of the umbrella. Bruce said he would think somebody is going to look at this space and say it is too good to pass up. This could create a huge monopoly for somebody. The first person there is going to be inundated with good loans. One of the people initially involved in drafting the CFPB guidelines and rules formed his own company to try to create products for the gap that is coming.
A black rock who has come up with loans for investors and is refying it with a hybrid product may convert it to bonds in order to sell the product. Cary asked if they are offering 30-year fixed or if they are doing some type of ARM product on it. Bruce said it is not an ARM product, but it is a shorter term fix and a lot of prepayment in the first few years. However, it is still better and also available. Regarding investor financing, Bruce wondered what chance he would have in the conventional world of getting his eleventh loan. Cary said with his company, it would be none. They are limited to Fannie/Freddie guidelines, and they do have the multi-finance product where you can have up to ten financed properties. Beyond this, they cannot do it.
It is just not there unless you go to a commercial type product where you have a line of credit. Bruce asked Cary if this is something they do, or if this too is out of the scope. They did just start doing seconds again, although it is not really an equity line product but rather a fixed-rate second. It is primarily for filling the gap on purchases. They will have challenges with the loan limits where they can put a second behind it. However, theirs is conservative and they only go to 80% combined loan-to-value. This makes sense, but it is better than not being there at all. This means you just loaned 100% of last year’s price.
There was a time they would drive around and hear an advertiser say they would 125% loan-to-value. Bruce wondered who took this on and why this made any sense. The question is who would fund this. Cary said he never did this product himself, but he knew this loan was out there and a lot of people too advantage of it. Bruce still wondered who would have funded it and how they would have funded it. Cary said it had to have been a private source, just like the subprime scenario. He cannot imaging there is not some gigantic portfolio looking at the market and seeing a huge hole where it would be safe. This is especially true with price aggression, where it just keeps getting safer and safer. It seems this niche has to be filled at some point.
Bruce said his main concern is when Black Rock is talking about putting together a fund that is $5 billion big, you suddenly realize that is a drop in the bucket. In the owner-occupant market, California alone goes through $160 billion in sales in a year. Now you better have a fund that is a lot bigger. Bruce said it would seem to him that this should be coming. Wells Fargo wrote an article they participated in last week. They said they thought the type of financing we are talking about that is not under the umbrella of qualified mortgage would be 40% of the market at some point. This is light years away from where we are right now.
Bruce asked what percentage of Cary’s business falls under the umbrella of qualified mortgage. Cary said it is probably 80% because they do not do that much jumbo in this market, although it could be as high as 90%. Bruce asked when jumbo officially starts. Cary said for Riverside and San Bernardino Counties it is over 417. Once you pass this, you are jumbo. They do not have the high balance like Orange and LA do. This not only affects single families, it also affects 2-4 units.
Regarding mortgage-backed securities, Bruce asked if this product enters into anything they do at Provident Mortgage or anyone else they know. He wondered if it is a viable exit plan at this point for loans. Cary thinks Wall Street is still doing this. They do not get involved with this at Provident since they are selling them off loan-by-loan to Chase or may do a pool of $2 or $5 million. They end off pooling them or selling them off in the secondary market or warehousing them and putting them in the portfolio. In the sequence, Chase would buy $2 ½ million worth of loans and pools them. Cary said they would pool a group of loans together, then they would sell a $5 million pool that has 30-40 loans in it. It is up to them whether they want to put it on their books or try to put a security together and sell it to Wall Street.
Once they have this gone, there will be more available room on their credit line to participate more. Once they get rid of this block, they have money freed up to go back out and put it up there again. Back in 2006, this was a pretty big percentage of what was happening. Everybody was able to get off what they were creating, and this is why the demand kept coming back saying they needed more since they did not have what they just created. You also have the flip-side of the coin where a company like New Century took $8 billion to market, and the market said they are not buying it. It obviously had an ending, and it ended for everybody inside of a very tight timeframe. Within a two-week time span there were several subprime companies that started going down, and New Century was just the first.
There was a website that was actually created that counted the number of lenders who were gone. Cary remembers this list and how crazy it was. There were big names on the list. In 2007 of 2008 Fannie and Freddie were suddenly bailed out along with Bear Stearns and Lieman Brothers. Bruce said these were days when he was watching the morning news with pretty great intensity and watching everything we were familiar with come down. There are rumors that the government wants to get rid of Fannie Mae and Freddie Mac, and Cary shudders to think what will happen if this occurs. Bruce did a presentation to them around 2011, and they were talking to pretty high-end people. He talked to Sean O’Toole about his feelings regarding that day, and he definitely felt that all those people thought that in ten years they would not have a job.
It is crazy because you look at how profitable they were prior to the crash. Granted, through the crash they had to get the bailout; but they have since paid back that money and had record profits the last couple years. They are hugely profitable, so the question is why you would want to get rid of this. The question is who is in charge and making these decisions because we figured out you are not supposed to loan to people who do not have any honest statement on their loan application. This was figured out now, although we should have known it already. There are some things you can do; and what they are doing now is probably creating the most ridiculously safe loans in the last 2-3 years. They are making a lot of money, so why would you pull the plug on that industry.
There is a big hole in our marketplace right now for new construction because we are not creating any sub-divisions in Riverside. Part of it is because these big builders are looking at it and asking how they are going to have funding for first-time buyers. If all of this starts changing and heading down in the amounts, they may not feel confident enough to be aggressive. Griffin Homes shifted gears with the crash and started buying floats. They are probably one of the biggest trustee sale buyers in all the local counties. They do about 60-80 sales a month. Cary said they are lucky to be able to participate in a small percentage of that because they got in with them about two years ago to where they were able to win some of the business when they resell. However, 60-80 flips a month is an enormous amount and a lot of volume.
Bruce wondered if this outpaced anything they could construct. Cary said they could make more money with less risk doing the flips than they could going out and buying land and putting the projects together. The thing about a flip is you have a containment in timeframe. You say you are buying today and plan to exit in six months. You have this window to worry about; and when you have a loan project you are out three years. They would be a player that may say to forget about the other thing and they are doing just fine with what they have. Cary said what is interesting now is they are just hearing how they are considering jumping back into the new home market. Cary thinks they will ride out the flip train as long as they can, but they do see light at the end of the tunnel for new home construction.
There have been rumors they have a project coming online here in the next twelve months over in the Yucaipa/Calimesa area. Bruce had talked to John Burns, who is a consultant for builders and hedge funds. He asked him about the mood of the builder, and he said what happened was the land prices were on sale for a while then all of a sudden went back to 2006 prices. Land cost is as high as it has ever been and literally does not pencil until you get back to 05/06 prices. Right now this median prices is $600 grand, and this is why there is no sub-division creation. You are still a ways away from something penciling unless you have an existing lot on sale. However, if you have to take a hill and make it some lots, you have a ways to go in price. You then have a longer journey in time than ever before.
Oddly enough, it is not typical for a builder to be shy about something they had issues with in the past. Normally they are very aggressive early and stay aggressive until somebody tells them nobody wants their things. This time, the land price is just preventing them. Whoever owns the land thinks very highly of it very quickly. This is what has been an issue. Cary said one of the things that scares him is Bruce’s prediction of the median price climbing to that 600 number and rates climbing to close to 6% or higher. It would be nice if the interest rates participated in getting to that ending point where basically the payment is too high for people to qualify.
What you do not want to have happen is go to $600 grand on the back of 4%. You are creating a disaster because you cannot always have 4% mortgage rates. This has not been typical in history. In 1985 it was only at 12 ½%, and it was only four years earlier Bruce had borrowed money at 17 ½%. To have a 4% mortgage, we think only because of recent history that this number is terrible. Cary said we bottomed out around May at 3 ¼ on FHA and 3 3/8 on conventional. We are up a full percent from May 1.
A lot of price gain was happening in the first 6-7 months, and it has calmed down since then. Bruce thinks you will get really busy again if you have not been because the aggression of people wanting to buy available homes has changed since the first lot. Cary said their volume has fallen off a bit over the last 4-6 months, but what they experienced a couple years ago was a mass influx of buyers and too much competition. They could not get offers accepted since some of these buyers were out there offering on 30 properties and still not getting one accepted. Their needs were not met; rather they just shelved their search. There were so many cash buyers at those price levels that they just got pushed out of the market. They still want to own a house, and that will be more the typical escrow this year. You are selling it to an owner-occupant who did not get their needs fulfilled last time.
Gifts are still allowed with FHA, even on conventional. With a conventional loan, if you are less than 20% down on a conventional loan you have to have 5% of your own money prior to any gifts. FHA has a totally different attitude and allows a 100% gift, which also includes closing costs. They used to have companies that were set up for this, such as the American Dream and Nehemiah. These are no longer allowed, so it has to be relative. Bruce asked if you can have a co-qualifying simultaneous to a gift. Even on conventional there are parents co-signing for kids. Freddie Mac has a program where they do what they call a blended ratio. This is where they put all the income of the family and all the debts into one big pot, and then they run the ratios.
Fannie Mae does not do it this way. They want the occupying borrower to qualify at 35/43 on their own income. This defeats the whole purpose of having a co-signer. Bruce also asked about FICO score requirements. For FHA the minimum is 620, and for Provident there are lenders who go down to 580 on the first mortgage. However, Cary said they have a 620 threshold with their investors. On the flip side with conventional, if it is 20% down you can go down to 620. With 10% down, it would have to be closer to 660. This is due to having to get the mortgage insurance approval. The lower the credit score, the higher the rate is going to be because of the pricing out on it. You have a rate, and if you don’t have enough down payment it changes the rate or just becomes unavailable. Every time there is a credit score decline, there is more charge for that loan.
FHA put out a chart that showed who they were loaning to in 2008. About 60-70% of FHA’s business was lent to under 600 at that time. Now it is something like 20%. This number as gone way up as far as the higher FICO scores. Cary said most of their buyers are probably falling between the 60 and 700 range. They even still do several that are over 720. In the end, despite what we are up against it looks like we will still be able to fund houses.
Check us out on our website at www.thenorrisgroup.com and be sure to tune in next week as Bruce continues his interview with Craig Hill.
Be sure to check us out on our website at www.thenorrisgroup.com.
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