We started the last edition of this book by writing "Nothing lasts forever, especially refi booms." The conclusion drawn was accurate but the refi boom of 2002/2003 didn't exactly hit a brick wall in 2004 and 2005. In 2004 refis slowed to 52.75% but in the first quarter of 2005 the average was 53.2%. According to figures compiled for this edition of the Mortgage Industry Directory, the refi boom peaked out in 2003 at 71.3% of all loan fundings. A refi rate in the 50s is still phenomenal which is why production volumes have been strong in 2004 and 2005. But the real catalyst driving the market is the record number of home purchase loans being funded. Refis may have peaked but when exactly the purchase market will hit its zenith is difficult to say. (See table.)

According to figures compiled for this book the residential purchase market set a record in 2004 with mortgage bankers funding $1.317 trillion. In 2005 purchase fundings will set a new record — $1.512 trillion. (The forecast is based on quarterly statistics collected by National Mortgage News and its affiliate, The Quarterly Data Report.)

There's no mystery surrounding the robust purchase money volumes being recorded by lenders. Mortgage rates continue to toy with new lows, and consumers from all walks of life want to achieve the "American dream of home ownership." The thirst for housing seems insatiable. In early 2005 single-family housing starts defied gravity, rising to an annualized pace of 1.775 million units. According to government figures, total housing starts (single and multifamily) advanced to 2.195 million units, a new 21-year high. Adding more lumber to the fire, existing homes sales came in at 6.89 million units in early 2005.

During the past two years starts and existing home sales have skyrocketed leaving economists, scratching their heads. "The ongoing vigor of the housing sector is confounding," Greenwich Capital said in a report. "Though some moderation is overdue, with the help of firming employment and income gains, housing demand may remain robust well into the spring, unless mortgage rates mover considerably higher." In early 2005 the yield on the 10-year Treasury was at 4.47%. At this book went to press in the summer the yield on the 10-year was back down to 4.1%.

Second Homes, Another Mortgage

Are the Baby Boomers doing to the second home market what they did to technology stocks a few years ago? A study by the National Association of Realtors says the second home market — vacation and "investment" properties — is on fire with such sales accounting for 36% of all homes sold in 2004.

The trade group, which for the first time did extensive research on the subject, found that 23% of all homes purchased were for investment while another 13% functioned as vacation homes. In 2004 a record 2.82 million in second homes were acquired, a 16% increase from the previous year.

Price increases for vacation homes have been among the strongest in the U.S. — particularly in shore, lake and resort areas. Mortgage bankers fund the purchase of second homes and recently some executives have reported that many buyers are using "interest-only" mortgages to finance their deals.

In general, homes that are non-owner occupied tend to have stricter underwriting standards, with some mortgage bankers requiring at least 20% down and charging a higher note rate. After analyzing Census Bureau figures for 2003, NAR estimates that there are 43.8 million second homes in the U.S., compared to 72.1 million owner-occupied units.

A NAR spokesman said he was surprised by what the trade group found and noted that many investors appear to be buying more than one second home. NAR — which based its findings on an eight-page survey it sent to 100,000 consumers who bought a home between August 2003 and July 2004 — said the typical vacation home buyer is 55 years old with total household income of $71,000.

The typical investment property buyer is 47 with a household income of $85,700. Baby boomers represent a post war demographic of 80 million Americans born between 1945 and 1964. Because Baby Boomers account for such a large percentage of the U.S. population of 300 million their buying habits can affect the pricing of whatever it is they purchase — be it stocks, homes, or other items.

NAR's spokesman says anecdotal evidence suggests that Boomers may have begun plowing money into second homes when technology stocks began correcting in 2000. One way to track how the mortgage market funds second homes is to look at how many investor property loans were bought by Fannie Mae and Freddie Mac.

Both those GSEs could not provide purchase figures for last year but did have information for 2003 and 2002. In 2003 Fannie purchased $57.1 billion in investor-owned one- to four-family loans, a 50% increase from the previous year. However, these mortgages accounted for just 4.2% of its loan acquisitions in 2003 — and 4.7% in 2002. (In 2003 the mortgage industry funded a record $3.9 trillion in loans and Fannie acquired a record $1.3 trillion in loans from mortgage bankers.)

Freddie Mac purchased $17 billion in investor-owned one- to four-family mortgages in 2003, compared to $16 billion the year before. NAR economist David Lereah said earlier studies on the second home market underestimated sales because a very small percentage of surveys mailed to second home addresses were returned. This time around NAR emailed the surveys to the actual owners of the second homes.

IOs, and 'Exotic' Mortgages Fueling the Fire?

What came first, the chicken or the egg? What came first, low-downpayment mortgage options or nose bleed housing prices? By now, most mortgage professionals are well aware of the boom in interest-only (IO), payment option loans, and other products that allow the consumer to pay as little as possible each month. The upside of these loans is the low payment feature. The downside is that the consumer doesn't build equity at all, and in the case of some payment option loans, is actually adding to the principal owed via negative amortization.

In the spring of 2005 Federal Reserve chairman Alan Greenspan, testifying before Congress, warned about the risk inherent in what he called "exotic" mortgages. The Fed chairman was specifically referring to IO and payment option loans. He also believes these instruments may be fueling a price bubble in certain geographic areas including California, the largest housing and mortgage market in the U.S. Is the Fed chairman all wet or is he on to something?
Mortgage bankers interviewed by National Mortgage News seem (so far) to be comfortable with IOs and the risk.

NMN, the publisher of this book, has been tracking the IO phenomenon for two quarters now and the results are hard to argue. The IO loan segment is extremely hot. Two years ago very few residential lenders were funding IOs but in the first quarter of 2005 these somewhat controversial products accounted for 21% of the entire production market in the U.S.

In the quarter the nation's lenders funded $141 billion in IO loans out of a total production pie of $663 billion. According to NMN, and its affiliate the Alternative Products QDR, the nation's top 25 funders of IO mortgages originated $79.8 billion in the first quarter — a stunning 312% increase from the same quarter last year.

Countrywide Home Loans, Calabasas, ranked first among all IO lenders with $13.7 billion, followed by Wells Fargo Home Mortgage, San Francisco ($9 billion) and the Lehman Brothers-owned Aurora Loan Services of Colorado ($8.7 billion). (Countrywide's volume is an estimate based on comments made by its CEO Angelo Mozilo in the Spring of 2005 that IO mortgages account for 25% of its total volume. For Countrywide, NMN assumed a 15% IO rate in the first quarter.)

Despite Mr. Greenspan's concerns, lenders are hardly backing away from IOs but the product is generating negative coverage in the general media — because of the concerns raised by Fed chairman Greenspan and others. But Mr. Greenspan wasn't the first to raise the "irrational exuberance" concern on IOs and payment option loans. That distinction belongs to Freddie Mac economist Frank Nothaft. In January NMN reported Mr. Nothaft's concerns about IOs, namely that the mortgages carry potential credit problems because, "no equity is being built up." (Even though the Freddie economist voiced his concern, the secondary giant introduced an IO product, called "Initial Interest," in July 2004. It is structured so the interest-only payments are fixed for the first three, five, and seven years before becoming a one-year ARM that is fully amortizing. It's common knowledge that Freddie likes the product and would like to buy more of it.)

One mortgage insurance executive told the newspaper that the IO is a fine product "for certain customers" but lenders are pushing it too aggressively to first-time home buyers. "It shouldn't be a first-time homebuyer product," he said. "There is going to be trouble one day." Then there's the rating agencies which are beginning to voice doubts about the loans.

Research on the IO market conducted by LoanPerformance found that in high cost areas volumes grew dramatically from 2001 to 2004. According to LoanPerformance, in San Diego (one of the most expensive housing markets in the U.S.) 14.46% of new mortgages are IOs compared to just 0.3% back in 2001. In Santa Rosa, Calif., another high cost market, IO production accounted for 14.29% of loans funded from January to October 2004 compared to just 0.2% in 2001. (The research firm's findings are based on its analysis of securitizations and servicing.)

Wall Street conduits -- which operate out of the public's eye in the secondary market — have been aggressive buyers of IO loans, adding liquidity by purchasing huge volumes from of the product.

Funders that are on the front lines originating the loans continue to defend the IO product. Mike Baldwin, president of LIME Financial, Lake Oswego, Ore., said an IO mortgage "gets people in a house" in high cost areas like California and on the East Coast. Mr. Baldwin said the loan LIME offers stays fixed for the first two years at least and then adjusts. "It is not a negative-am," product he said.

About 40% of LIME's purchase money production is IO. (LIME funded $1 billion in loans last year, 70% of its production being purchase money loans.) The LIME president told us "The rating agencies are skeptical about" IO loans but his shop has yet to see any credit problems.

Dan Perl, who runs First Street Financial, Irvine, Calif., a non-conforming lender, said IO loans, "are not a bad deal. It's no different than a credit card but there's collateral." IO mortgages account for about 15% of what First Street finances. Mr. Perl said he will not fund the loans unless the credit score on the borrower is at least 600. "We won't do negative-am loans," he said.

So, is the IO market going to burst? Don't bet on it, at least not any time soon. Still, it's a product to keep an eye on, along with the payment option loan where the consumer is given one of four payment choices each month, one of which allows them to chose the lowest possible payment. One top ranked lender told us that 50% of its payment option customers chose the lowest payment each month. That's not a promising sign.

A Few Words About Subprime, Most of it Good

Mortgage bankers funded a record $608 billion in residential subprime loans in 2004, a stunning 55% increase in production. (See table.) The way things stand the nonconforming industry will originate $580 billion in 2005, not bad for a sector that crashed and burned in the fall of 1998 and stumbled for three years before regaining its footing. (For a primer on what happened in 1998 you may want to buy a back copy of the MID on eBay.)

But what's so amazing about subprime is that the gains came while the overall residential loan market — prime, FHA/VA, jumbo — declined by 28% to $2.79 trillion. According to figures compiled for the MID, subprime production accounted for 21.8% of all residential production last year, the largest annual market share reading since National Mortgage News began collecting production figures ten years ago. (In the fourth quarter a record $168 billion in subprime loans were funded compared to $699 billion in the overall origination market — a B&C market share of 24%, a quarterly record.)

Mortgage executives and investment bankers believe there are several explanations for the boom, including increased liquidity brought to the market by the presence of so many Wall Street conduits. Also, some believe the recession that started earlier in the decade increased the number of potential subprime borrowers who were able to tap home equity that didn't exist a few years ago.

However, anecdotal evidence suggests that the subprime lenders aren't just subprime anymore. Many top ranked subprime funders — Ameriquest, First Franklin, New Century — are major funders of IO and payment option ARMs, two products we talked about earlier. It's common knowledge that subprime volume leaders Ameriquest and New Century are funding on the fringes of the conventional market. Conclusion: as prime firms invade the turf of traditional subprime lenders, subprime lenders are funding an increasing amount of "almost conventional" and conventional home loans.

The Ameriquest Threat

No analysis of subprime is complete without talking a little bit about the largest player in the market, Ameriquest Mortgage of Orange, Calif., and its wholesale affiliate Argent Mortgage. (Both are controlled by the privately held Ameriquest Capital Corp., a company headed by mortgage industry veteran Roland Arnel, a man who values his privacy.) In the spring of 2005 Ameriquest CEO Wayne Lee, a 15-year veteran of the company departed, fueling all sorts of unsubstantiated speculation about the company.

Here's what we know about Ameriquest/Argent: It funded a record $77.5 billion in loans in 2004, more than doubling its production volume from the year before. It likely will end 2005 funding about the same, a decent accomplishment when you consider how fast it has grown in such a short period of time. (See table.)

Ameriquest didn't have a record year in 2004 because its name begins with an 'A' and it's listed first in the telephone book. It markets its brand from coast-to-coast, leaving no stone unturned. Not only did the company purchase the naming rights to the Texas Rangers baseball stadium but it also owns the right field fence at Camden Yards and several other sporting arenas. Click on the Internet and you can find the Ameriquest brand advertised all over the place — as well as on TV and Radio. (Its 'infomercials' are a staple on some late night cable shows. And the shows are well produced and balanced.)

And the company doesn't stop there either. It aggressively markets the name of its wholesale division, Argent, the loan brokerage community. In short, Ameriquest lives by the edict: you rest, you rust.

For two years now it has been toying with the idea of taking part of its mortgage empire public. Even though the IPO never materialized its owners (Mr. Arnel chief among them) have contemplated a bond offering that could bring in as much as $1.2 billion.

The company has never publicly commented on its IPO and bond plans and likely will not do so until it gets closer to an official offering date. (That is, if it decides to pull the trigger.) As one ACC spokeswoman put it: "The company, as a matter of policy, does not comment on rumors in the market place."

Executives who compete against Ameriquest Mortgage believe negative publicity surrounding some of its lending practices may have played a role in scuttling the IPO. In early 2005 the company disclosed that it was negotiating with 25 "regulatory agencies and/or attorney general" regarding concerns over some of its retail lending practices.

Ameriquest disclosed the states are concerned about these issues: the "appropriateness" of discount points charged prior to February 2003; the accuracy of appraisal valuations; stated income loans; "oral" statements made to borrowers regarding loan terms, and its policies on funding Native American reservation properties. Regardless of why Mr. Lee left and how settlement talks go with the states, Ameriquest isn't going away. Competitors — especially publicly traded ones — are less than thrilled with the company because it has been so successful and can survive at lower profit margins (that's the beauty of being private). Of all the players in mortgage banking it may very well be the most interesting one to watch in the coming year.

The Outlook, Firms to Watch, the GSEs, and More

Even though Ameriquest is a must-watch company there are many other mortgage firms of note in the industry and we don't mean to disregard them. Enough can't be said about industry leader Countrywide Home Loans whose CEO Angelo Mozilo, a five decade veteran of home finance, should be what ever mortgage chief strives to be. Not only is Countrywide the number one ranked lender and servicer in the U.S. it soon may challenge Ameriquest for the number one spot in subprime.

Countrywide is a perfect example of a company that spots lending trends early, jumps on them, but isn't so quick to the draw that it makes big mistakes. It is a major player in not only IOs and subprime but jumbos and HELOCs. The biggest issue facing Countrywide: how it will perform after Mr. Mozilo leaves in a few years.

Over the past decade the California-based company's servicing share grew by 253% while its receivables jumped by 711%. (At the end of March 2005, Countrywide serviced $893 billion in home mortgages, about $20 billion ahead of the No. 2 ranked Wells Fargo.) Mr. Mozilo has long expressed his desire to see Countrywide have a 20% market share. Can Mr. Mozilo and his crew pull it off? (For further analysis see chapter 4 on servicing.)

Also, enough can't be said about some of Countrywide's peers and near-peers: Wells Fargo Mortgage, Washington Mutual, Chase Home Finance, Citigroup, GMAC, National City, World Savings and IndyMac. All are tough competitors, understand the business, and (for the most part) are well managed. If any of the aforementioned leave the industry over the next two years it would be a shocking development.

One of the key (and constant) issues facing mortgage bankers is industry consolidation. Even though there are more mortgage bankers operating today (8,200) than four years ago, the five largest funders of loans control more of the production business than ever before. (See table.) The industry has morphed into one where the big fish — Countrywide, Wells, WaMu, Chase, Citigroup, take your pick — table fund and purchase closed loans from an increasing array of smaller shops. (The old 'whales & minnow' analogy.)

Over the past decade consolidation has been rampant among the top funders in both prime and subprime. That trend likely will continue in the years ahead. Depositories — Countrywide, Wells, WaMu, Citigroup, Chase — will be the likely survivors and buyers of other shops but don't count out the middle-sized firms quite yet. Not too long ago Wells and WaMu weren't all that large either.

As for Fannie Mae and Freddie Mac, predicting their future is a bit more complicated. Both are working their ways through multi-billion dollar accounting scandals. Freddie Mac, whose scandal broke first (June 2003) and was less severe financially, is on the verge of reporting current earnings once more.

There is little doubt in the industry that Freddie is financially in better shape than its "big sister" Fannie Mae. Moreover, Freddie is once again growing its portfolio while Fannie's shrinks.

In April of 2005 Freddie bought more loans than its cross-town competitor, the first time in a decade it outpurchased Fannie in a given month. During the 30-day period Freddie acquired $48.5 billion in mortgages to Fannie's $45.2 billion.

Historically, Fannie's purchases have been $10 billion to $25 billion greater than Freddie's each month but in the wake of the former’s $12 billion accounting scandal, Fannie Mae has been losing market share and Freddie has been closing the gap. Seller/servicers say Freddie Mac is gearing up to aggressively purchase interest-only mortgages, a product that Fannie Mae, so far, has ignored. Even though Freddie outpurchased Fannie in April, year-to-date Fannie has acquired $175.7 billion to Freddie's $159.9 billion, a difference of $15.8 billion.

The two are slated to have a new, tougher regulator soon, and it is unlikely that their enemies (large banks, mortgage insurance companies) are going to lay-off lobbying against them in Congress and battling their expansionist tendencies.

One Last Word

Analyzing the residential mortgage sector in an annual tome is never an easy thing to do. (Please visit the eMID, the electronic version of the MID, for occasional updates.) Veterans of residential finance know that sometimes the mortgage business can turn on a dime. The key — as always — is interest rates, but other factors come into play as well: the yield curve (the spread between short and long term rates), competition in the secondary market, liquidity, home values, the overall employment picture, just to name a few.

It is unlikely that lenders soon will see another year like 2003 ($3.9 trillion in production thanks to record refis) but the next few years should be steady and stable, without any significant peaks and valleys. And that's not so bad, not at all. — Paul.Muolo@SourceMedia.com.