Newly Proposed Rules Could Raise Rates on Consumer Mortgages and Price Out Households

December 13, 2012

On balance, the residential housing market has been improving in recent months, but the pace of recovery is partly restrained by frictions in the mortgage market.

Against this backdrop, U.S. regulators have proposed comprehensive new regulatory capital requirements for U.S. banking organizations.  These newly proposed rules will serve to implement Basel III, the most recent revision to international bank regulatory capital standards, in the U.S. They also reflect the implementation of certain aspects of the Dodd-Frank Act, excluding the Dodd-Frank Act’s language addressing qualified mortgages and qualified residential mortgages, which was signed into law during the summer of 2010.

The Basel III regulations directly address single family residential loans that are made to consumers and remain on bank balance sheets.  They will also target the loans made to builders of these homes as well as off-balance sheet loans.  The analysis described below focuses on Basel III’s impact on single family residential loans that are made to consumers and remain on bank balance sheets. Future work will assess the impact of newly proposed regulations on builders of single family homes and on the residential mortgages that are moved off of a bank’s balance sheet.

If adopted as proposed by the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency, the U.S. version of Basel III would require banks to increase the amount of capital used to fund the single family residential real estate loans that remain on the balance sheet of banks by assigning these loans a greater risk weighting. The risk weight identifies the amount of an asset, in percentage terms, which must be backed by at least 8.0% of capital. In addition, the FDIC would separate single family residential mortgages into two risk categories, category 1 and category 2. The proposed definition of category 1 residential mortgage exposures would generally include traditional, first-lien, prudently underwritten mortgage loans. The proposed definition of category 2 residential mortgage exposures would generally include junior-liens and non-traditional mortgage products.

Raising the risk weight as described above increases the cost of consumer loan funding by both increasing the amount of relatively more expensive capital funding required and lowering the amount of relatively less expensive deposit funding needed. As a result, by raising the total cost of funding, implementation of the newly proposed rules directly addressing on-balance sheet mortgage purchase loans for single family homes could further restrict the supply of mortgage credit. In a competitive market, higher funding costs would produce a matching increase in consumer mortgage rates and price some households out of a real estate market

Recent calculations made by the Mortgage Bankers Association (MBA) demonstrate how these new regulations will likely raise funding costs and mortgage rates for some consumers. According to the MBA, a category 1 mortgage with both a loan-to-value ratio (LTV) of 95.0 and mortgage insurance would cost 2.52% under current capital requirements. However, under the proposed Basel III risk weights, that same mortgage would cost 3.04%, an increase of 0.52 percentage points. The increase in cost, and by extension the mortgage rate faced by these consumers, reflects an increase in risk assigned to these mortgages. Under current capital requirements, these loans are assigned a risk weight of 50.0%, while under Basel III rules, the risk weight would be 100.0%.

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Research by NAHB illustrates the effect that higher mortgage rates would have on housing affordability. This research indicates that an increase in mortgage rates from 2.5% to 3.0% would leave more than 2.2 million households priced out of the market for a median-priced new home.  The decline in housing affordability that results from increased consumer mortgage rates reflects an increase in both the monthly mortgage payment and the minimum income needed to purchase a home. NAHB estimates that an increase in mortgage rates from 2.50% to 3.00% would raise monthly mortgage payments by $56 per month and raise the minimum income needed by $2,373 to $51,871.

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Despite the Recent Increase, Credit Card Debt Outstanding Remains On A Downward Path

December 11, 2012

According to the Federal Reserve Board, consumer credit outstanding increased at a seasonally adjusted annual rate of 6.2% in October, an acceleration of 0.8 percentage points over September’s growth rate. Unlike September, the October increase in consumer credit outstanding, which excludes loans secured by real estate, reflects growth in both revolving and non-revolving credit. In October, revolving credit expanded by 4.7%, reversing September’s 3.1% contraction. Non-revolving credit increased by 6.9%. However, the October growth rate in non-revolving credit outstanding decelerated from the rates of growth exhibited in August, 9.0%, and September, 9.2%.

As the chart below illustrates, the recent increase in the amount of consumer credit outstanding reflects an expansion in non-revolving credit outstanding. Meanwhile, revolving credit outstanding has increased modestly. Between January 2000 and July 2008, when the amount of revolving credit outstanding reached its peak, revolving credit outstanding rose by 67.2%. Over this same period, the amount of non-revolving credit outstanding more than doubled, growing by 105.1%.

Between July 2008 and April 2011, larger non-revolving credit outstanding rose by 10.8%, which included a shift of consumer credit from pools of securitized assets to other categories largely due to financial institutions’ implementation of the FAS 166/167 accounting rules, but this increase was offset by an 18.0% decline in the smaller revolving credit outstanding. As a result, total consumer credit outstanding fell by 0.7%. Since April 2011, total consumer credit outstanding has expanded by 15.0%. Non-revolving credit outstanding has increased by 26.8% while revolving credit outstanding has grown by only 1.8%.

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Changes in the amount of consumer credit outstanding largely reflect changes in auto, student, and credit card debt outstanding. According to the Federal Reserve Board, credit card loans account for most of revolving consumer credit, but other types, such as prearranged overdraft plans are also included. Meanwhile, student and auto loans account for the bulk of non- revolving credit. As the chart below illustrates, while the amount outstanding for auto and student loans has seen a sustained increase since the third quarter of 2010, credit card debt outstanding has continued its descent.

Between the first quarter of 2003 and the fourth quarter of 2008, the 27.4% increase in consumer credit was broadly distributed among its major underlying categories. During this period, auto loans rose by 23.4% while credit card debt expanded by 25.9%. Student loans surged by 165.6%, although it started from a comparably lower level. Between the fourth quarter of 2008 and the third quarter of 2010, consumer credit fell by 5.9%. Auto and credit card debt outstanding contracted by 10.2% and 15.6% respectively, while student loans debt continues its ascent, increasing by 21.7% over this period.

Since the third quarter of 2010, consumer credit outstanding has expanded. Part of this increase reflects an accounting change. In addition to this accounting change, the principal categories of non-revolving debt have grown. Over the last 9 quarters, auto loans outstanding have increased by 8.2% and student loans have grown by 22.8%. However, credit card debt outstanding experienced a contraction of 8.0%. The shrinking of credit card debt outstanding, which has narrowed by 29.1% since the fourth quarter of 2008 and is now below its 2003 level, may reflect changes in household spending patterns.

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Household Balance Sheets Strengthen As Their Debt Outstanding Falls

November 29, 2012

The Federal Reserve Bank of New York recently reported that aggregate household debt outstanding was $11.31 trillion on a not seasonally adjusted basis in the third quarter of 2012, $74.00 billion less than the amount outstanding in the second quarter of 2012. In the third quarter of 2012, outstanding debt secured by real estate fell by $135.00 billion from the second quarter. Outstanding debt secured by real estate is largely composed of mortgages, but also includes home equity lines of credit. However, the decline in outstanding debt secured by real estate was partly offset by the $61.00 billion increase in consumer debt outstanding. The decline in aggregate household debt outstanding in the third quarter of 2012 continues the multi-year trend of falling debt outstanding. Since peaking at $12.68 trillion in the third quarter of 2008, the total amount of household debt outstanding has fallen by 10.77%.

As the chart below illustrates, the rise and decline in total debt outstanding over the previous ten years reflects changes in outstanding debt secured by real estate. However, outstanding debt secured by real estate as a share of total debt outstanding has fallen slightly as declining real estate secured debt is offset by rising consumer debt outstanding. Between the first quarter of 2003 and the third quarter of 2008, total debt outstanding grew by $5.44 trillion. Over this same period real estate secured debt outstanding grew by $4.80 trillion while consumer debt outstanding expanded by $0.64 trillion. Meanwhile, the $1.37 trillion decline in total household debt outstanding since the third quarter of 2008 reflects the $1.39 trillion decline in real estate secured debt during the same period. However, consumer debt outstanding grew modestly, rising by $20.00 billion over the past four years.

In addition to falling levels of household debt, disposable personal income has risen. As a result, the household debt ratio, the share of debt payments to disposable personal income has declined dramatically. The household debt ratio conveys the ability of households to meet their debt obligations. As the chart below illustrates, the ratio of household debt rose slightly during the housing boom. Between the first quarter of 2003 and the third quarter of 2007, the household debt ratio rose by 0.92 percentage point to 14.05%. Although disposable personal income grew, which should lower the household debt ratio, total household debt outstanding rose even faster. Over this period disposable personal income rose by 27.94% but aggregate household debt outstanding expanded by 67.78%. Between the second quarter of 2008 and the first quarter of 2009, the household debt ratio experienced a slight rebound. This uptick reflects a decline in disposable personal income. The 4.39% decrease in personal income exceeded the 0.55% decline in aggregate household debt outstanding.

After peaking in the third quarter of 2007, the aggregate household debt ratio has since fallen by 3.36 percentage points to 10.69%. The decline in the household debt ratio reflects both a decrease in total household debt outstanding and an increase in disposable personal income. Since the first quarter of 2009, aggregate debt outstanding according to data compiled by the Federal Reserve Bank of New York, contracted by 9.73%. Over this same period, disposable personal income increased by 11.51%. The decline in the household debt ratio resulting from both a smaller level of debt outstanding and more disposable personal income suggests that household balance sheets are strengthening and their ability to service their debt is improving.


Fed Chairman Bernanke on Mortgage Lending

November 15, 2012

In prepared comments, the Chairman of the Federal Reserve System, Ben Bernanke, addressed the challenges in housing and mortgage markets. Chairman Bernanke’s comments contained a clear message: tight lending standards that emerged after the housing boom are now holding back the housing market recovery and the economy as a whole.

“It seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes, thereby slowing the revival in housing and impeding the economic recovery.”

As part of these remarks, the Chairman noted the central role played by the housing sector within the overall economy. After reaching a low, many housing market indicators including starts, sales, and prices now indicate that the housing market is beginning to recover. However, the Chairman noted that “while it is encouraging that we are seeing signs of improvement in the housing market in most parts of the country….the housing sector is far from out of the woods”. He highlighted the mortgage market as a key component of housing still showing signs of strain. Addressing frictions in the mortgage market can consolidate gains made elsewhere in the housing sector.

Weakened mortgage demand partly accounts for declines in mortgage lending. The Chairman noted that “the reduction in mortgage originations and home purchases for all groups relative to the pre-crisis period partly reflects weakness in the effective demand for housing.” Analysis of the October Federal Reserve Board’s Senior Loan Officer Opinion Survey illustrate that demand for prime residential mortgages is growing, on net. However, the actual increase has been slight, implying that growth in sales of single-family residential homes may reflect the growing role played by all-cash sales.

The Chairman noted that “while the decline in the number of willing and qualified potential homebuyers explains some of the contraction in mortgage lending of the past few years…tight credit nevertheless remains an important factor as well.” Analysis of the most recent release of the Federal Reserve Board’s Senior Loan Officer Opinion Survey confirms this point. The October survey continues to illustrate that lending standards affecting the supply of prime residential mortgages remain basically unchanged at still tight levels while demand for prime residential mortgages is strengthening. On net, survey respondents indicated that obtaining a prime residential mortgage has become slightly easier over the past three months. In the October survey, 4.7% of respondents indicated that they had eased their lending standards, while 3.1% of banks reported having tightened them. However, this change was small and the vast majority of firms, 92.2% kept their lending standards basically the same. Although banks may be reluctant to finance residential home purchases, the likelihood that they will extend credit for other consumer loans is growing.

The Federal Open Market Committee, also chaired by Bernanke, has taken extraordinary steps to lower mortgages rates. In his speech, Chairman Bernanke further clarified that “the actions taken by the FOMC to put downward pressure on longer-term interest rates was meant to inspire greater confidence for individuals, families, businesses, and financial markets” and he reiterated the commitment of the Federal Reserve to “promoting a sustainable recovery within the context of price stability until the job market improves substantially.”


Consumer Credit Outstanding Climbs as Student Loans Continue To Rise

November 9, 2012

The Federal Reserve Board reported that consumer credit outstanding rose at a seasonally adjusted annual rate of 5.0% in September to $2.7 trillion. The over-the-month increase in consumer credit outstanding, which excludes real estate secured loans such as mortgages and home equity lines of credit, reflected a 9.2% rise in non-revolving credit outstanding, 0.1 percentage point higher than the growth rate observed in August. The September increase in non-revolving credit outstanding, which includes automobile and student loan debt, was partially offset by a 4.1% decline in revolving credit. The monthly decline in revolving credit outstanding, which is largely composed of credit card debt, reverses the 6.1% increase that occurred in August. In the third quarter of 2012, revolving credit outstanding fell by 1.6% while non-revolving credit outstanding rose by 6.6%.

Prior to a two-year decline that began in August 2008, consumer credit outstanding had experienced a long period of steady growth. However, the underlying source of growth changed during this time period. Between January 2000 and July 2008, consumer credit outstanding had expanded by 67.9% to $2.6 trillion. During the 2000 to 2005 period, growth in consumer credit outstanding largely reflected the $532.4 billion increase in non-revolving credit. Revolving credit outstanding grew by $214.7 billion over this period. However, revolving credit outstanding was the primary source of growth between January 2006 and July 2008. It also contributed to the decline in consumer credit outstanding in the two year period between August 2008 and September 2010. Between January 2006 and July 2008, non-revolving credit outstanding grew by $86.1 billion, but revolving credit outstanding widened by $198.5 billion. In the 27 months that followed, the $160.2 billion contraction in revolving credit outstanding largely accounted for the $184.4 billion decrease in consumer credit outstanding.

Since September 2010, consumer credit outstanding has resumed its upward trajectory. Over the last two years, consumer credit outstanding has grown by $338.3 billion. Consumer credit outstanding is now 7.0% above its pre-recession level and 6.0% above its July 2008 level. The increase in non-revolving credit outstanding has been the primary source of this increase. Between October 2010 and September 2012 non-revolving credit outstanding has expanded by $354.1 billion while revolving credit outstanding has declined. Part of the increase reflects a November 2010 shift of consumer credit from pools of securitized assets to other categories largely due to financial institutions’ implementation of the FAS 166/167 accounting rules. However, following November 2010, the increase in consumer credit outstanding is the result of a $206.7 billion increase in non-revolving credit outstanding, while revolving credit remained generally flat.

Data from the Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit suggest that the expansion of non-revolving debt outstanding reflects a sustained rise in the student loan debt balance. Between the first quarter of 2003 and the second quarter of 2012 the student loan debt balance rose by $673.3 billion, nearly three times its first quarter 2003 level. Meanwhile, the amount of auto loans outstanding has increased only slightly. In contrast to this dramatic increase in student debt outstanding, auto loans rose by only $109.0 billion between the third quarter of 2003 and the second quarter of 2012. After peaking at $830.0 billion in the third quarter of 2005, the auto loan debt balance remained relatively flat before it began to fall in the first quarter of 2009. Although the amount of auto debt outstanding started to rise in the first quarter of 2011, it remains 9.6% below its peak. Recent patterns in consumer credit outstanding reflect a recession-recovery cycle: declining debt associated with discretionary purchases (e.g., credit cards and auto loans) and increases in student loans as students postpone entering the workforce and workers retool their skills in a depressed economy.


Lending Standards on Prime Residential Mortgages Ease Only Slightly but Demand Remains Strong

November 5, 2012

Results from the Federal Reserve Board’s Senior Loan Officer Opinion Survey indicate that, on net, a small fraction of banks eased their lending standards for business and consumer loans over the previous three months. They also reported that respondents noticed little change in residential real estate lending standards on balance. Meanwhile, a significant share of banks reported a strengthening of demand for commercial real estate loans, residential mortgages, and auto loans, while demand for other types of loans was relatively unchanged.

In its October iteration, the Federal Reserve included special questions for senior bank loan officers regarding lending standards on FHA-insured purchase mortgages and their respective bank’s use of the Home Affordable Refinance Program. Banks reported that they were more willing to approve an FHA mortgage for borrowers with a higher FICO score.  Applications with lower FICO scores were less likely to be approved for a FHA-insured purchase mortgage. At the same time, 41.9% of banks surveyed estimated that the Home Affordable Refinance Program accounted for between 10% and 30% of refinance applications received in the previous three months. This result was 11.9 percentage points greater than when the question was posed in July.

The October survey continues to illustrate that lending standards affecting the supply of prime residential mortgages remain basically unchanged at still tight levels while demand for prime residential mortgages is strengthening. On net, survey respondents indicated that obtaining a prime residential mortgage has become slightly easier over the past three months. In the October survey, 4.7% of respondents indicated that they had eased their lending standards, while 3.1% of banks reported having tightened them. However, this change was small and the vast majority of firms, 92.2% kept their lending standards basically the same.

While lending standards have remained relatively unchanged since the second quarter of 2010, bank respondents have indicated that demand for prime residential mortgages is growing, on net. Although demand growth dipped somewhat in the latest survey release, the share of banks reporting stronger demand for residential mortgages continues to exceed the percentage for banks experiencing weaker demand by a wide margin. Thirty-nine percent of respondents indicated that demand for prime residential mortgages had strengthened over the past three months, while 6.3% reported that demand had weakened. In the previous release, 57.3% of respondents indicated that demand for prime residential mortgages was stronger, while 4.9% indicated that demand was weaker. Since the survey’s release in April 2011, when 34.0% of banks indicated that demand for residential mortgages was weaker on net, a growing percentage of banks have observed strong demand for prime residential mortgages.

Although banks may be reluctant to finance residential home purchases, the likelihood that they will extend credit for other consumer loans is growing. On net, 32.8% of banks reported stronger demand for prime residential mortgages; only a net of 1.6% of respondents eased their credit standards on these products. However, for other consumer loans, the percent of banks easing credit standards is occurring at the same time that banks are also experiencing a stronger demand for these loan products, facilitating the likelihood of bank lending. Eleven percent of banks reported easing credit standards for credit cards and 8.5% of respondents experienced stronger demand for credit cards. Ten percent of banks indicated that lending standards had eased for automobile loans while 16.9% of respondents indicated that demand for automobile loans was stronger on net. Meanwhile, 3.1% of senior loan officers reported that credit standards had eased on all other consumer loans while 4.8% of banks indicated that demand for these loans had strengthened on net. While the combination of strong demand and easier lending standards is likely improving bank lending in most consumer loan markets, sticky lending standards in the residential mortgage market may be contributing to a shortage of prime residential mortgages and slowing the recovery in the residential housing market.


Mortgage Applications For Purchase Remain Flat Even As Home Sales Climb

November 1, 2012

According to recently released data by the Mortgage Bankers Association, total mortgage applications fell by 4.8% in the week ending on October 26, 2012. This is the fourth consecutive week that the index has fallen. The most recent decline in total mortgage applications reflects a decrease in applications for refinancing. The 6.0% decline in the index of refinancing applications was only partly offset by the 0.5 percent increase in the mortgage applications for purchase index. Mortgage applications for refinancing represent 80.0% of all mortgage applications. Meanwhile, the Federal Home Loan Mortgage Corporation, Freddie Mac, reported that the 30-year fixed rate mortgage fell by 2 basis points to settle at 3.39% in the week ending on November 1, 2012.

The broader decline in the 30-year fixed mortgage rate that began in February 2011 has had a noticeable impact on demand for refinancing, but mortgage applications for purchase have remained unresponsive. Since February 2011 the 30-year fixed mortgage rate has fallen by 164 basis points from 5.05 percent while mortgage applications for refinancing have more than doubled, growing by 114%. In contrast, the mortgage applications for purchase index has remained essentially flat. After peaking in 2006, mortgage applications for purchase fell dramatically and is now below the level seen in the previous decade. Since February 2011, the mortgage applications for purchase index has declined by 0.4%.

The trend in the mortgage applications for purchase index is often interpreted as a leading indicator of home sales.  Although mortgage applications for purchase have remained relatively unchanged since February 2011, single-family home sales have trended higher. Over this same period, combined sales of new and existing single-family homes have grown by 15.4%. Sales of new single-family homes have risen by 42.5% and single-family existing home sales have increased by 13.5%. Growth in sales of single-family residential homes may reflect the growing role played by all-cash sales. In its latest release, the National Association of Realtors (NAR) revealed that all-cash sales of existing homes rose by 1.0 percentage point to 28% between August 2012 and September 2012 and is nearly double the rate of four years ago. Growth in all-cash sales helps to explain the observed divergence between single-family home sales and the mortgage applications for purchase index.

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MBA Data Suggest Mortgage Demand for Home Purchase Is In Early Stages of Recovery

October 18, 2012

According to the Mortgage Bankers Association (MBA), the seasonally adjusted total mortgage applications index, a measure of mortgage demand, declined by 4.2% in the week ending on October 12, 2012. The reported decline in the weekly total mortgage applications index reflected a 5.3% decrease in MBA’s total refinance application index. Applications for refinancing represent 81.7% of total applications. While the applications for refinancing declined, the applications for purchases index rose by 1.0%. Despite this most recent release, applications for refinancing have moved broadly higher since the beginning of 2011 whereas the mortgage applications for purchase index has trended flat since 2010.

Data from the Federal Home Loan Mortgage Corporation, Freddie Mac, show that mortgage interest rates continued their descent. In the week ending October 18, 2012, the 30-year fixed rate mortgage settled at 3.37%, a 2 basis point decline from the previous week. The newly released data is consistent with the broader trend of lower mortgage rates. The path of mortgage rates largely reflects the actions taken by the Federal Reserve’s Federal Open Market Committee (FOMC), including their most recent announcement that they will begin purchasing $40 billion of agency mortgage-backed securities, to push interest rates down. Since this FOMC statement was released on September 13th, the 30-year mortgage rate has fallen by 22 basis points on a weekly basis and the spread between the 30-year mortgage and the 10-year Treasury note has tightened by 34 basis points.

Although total mortgage applications for purchase have remained flat, the underlying components have begun to normalize. Historically, demand for conventional mortgages for purchase exceeds those of government mortgages. Between 2000 and 2002, the spread between these two indices averaged 229.0 points. During the housing boom, this difference rose to an average of 550.0 points as conventional mortgage applications for purchase became easier to obtain. Following a steep decline in conventional mortgage applications for purchase, demand for conventional mortgages for purchase leveled off in 2010 and 2011 and matched the government mortgage applications for purchase index. Since the beginning of this year, conventional mortgage applications have risen by 44.2% and again exceed their government counterpart. Recent acceleration in conventional mortgage applications for purchase suggests that mortgage demand is strengthening, though it remains well below normal. Since government mortgage applications for purchase were less effected by the boom and bust cycle in the housing market, restoring the level of total mortgage applications will require continued recovery on the conventional side.