While the market focused on
10,000 and two little words from the
Tuesday, it was the mortgage lending industry that made the most noise, throwing cold water on the entire banking sector.
, the nation's largest savings and loan, warned that its earnings will be lower than expected due to a decrease in mortgage volume and other factors. Its stock dropped $3.57, or 8%, to $40.28 after the announcement. The Philadelphia Bank Sector Index dropped 11.95, or 1.3%, to 939.40.
To be sure, it has been a stellar year for banks, homebuilders and anyone else associated with the skyrocketing housing industry. The Philadelphia Bank Sector Index has risen from 772 to 939, or 21%, for the year. Component stocks focused on mortgage origination have done even better than that.
But now may be a good time to consider whether the bull run in mortgage lending stocks has reached its peak.
The Washington Mutual announcement was blunt and seemed to reverberate across the board as the entire sector was down from the opening bell, while the rest of the market attempted and abandoned a weak rally toward Dow 10,000. Every major bank and mortgage originator was down for the day, in some cases sharply.
Predictions as to the end of the mortgage boom have been in the public domain for months, but Washington Mutual CEO Kerry Killinger went a ways toward confirming those predictions Tuesday with hard numbers. Calling the outlook for the mortgage market "uncertain," he sang the swan song for the conditions of the last few years that have produced outsize results.
"Washington Mutual benefited from extraordinary mortgage volumes over the past few years, which allowed us to fund the expansion of a national retail banking franchise and multifamily lending business while producing solid earnings growth," Killinger said. "Now that the mortgage market has clearly slowed, we are adjusting our business to adapt to the new realities of the current environment."
Even as the Federal Reserve left the discount rate at 1% and reiterated its apparently magic phrase that it will keep it there for a "considerable period," mortgage forecasters are factoring in interest rate hikes that will affect bank profitability as the refinancing volume continues to free-fall.
The Mortgage Bankers Association predicted in November that mortgage originations would decrease by about 50% from $1.1 billion to $535 million between the third and fourth quarters. And the bleeding is not expected to stop. By the third quarter of 2004, originations are expected to drop 60% to $432 million before bottoming out at $324 million by the end of the year. Washington Mutual's revised fourth-quarter forecast mirrors the MBA predictions saying its fourth-quarter origination volume will drop 50% vs. the third quarter.
This volume decline directly affects loan profitability. Killinger said that competitive pricing pressure in the shrinking market will drive Washington Mutual's gain per loan down 79%, from 47 basis points to 10, between the second and fourth quarters of 2003. Without offering numbers, he also said profits would be hurt by an increasing emphasis on adjustable-rate mortgages.
Adjustable-rate mortgages are forecast to play a much larger role in the mortgage origination market in 2004. In the third quarter of 2003, 18% of the $1.1 billion in new loans were adjustable, while 68% were refinances. By the fourth quarter, 26% of all mortgages are expected to be adjustable. The figure is expected to stay the same throughout 2004, at which point they will account for $81 billion of the anticipated $324 billion total.
Adjustable-rate loans carry a lower interest rate than fixed-rate loans. While such loans are nice for people who may not plan to be in a property for 15 or 30 years, the loans also are used to get marginal mortgage applicants approved, and, according to the National Realtors Association (NAR), affordability is slipping even before interest rates actually go up.
The NAR publishes its Housing Affordability Index comparing family income to mortgages, with a value of 100 representing the exact point at which median family income matches what is required to get a mortgage on the median-priced home with a 20% down payment. The index peaked at 145.2 in March and already had slipped 6% to 136 by September. Rising interest rates will ultimately drive the index, along with loan originations, lower.
The alternatives to this scenario would be either lower home prices or sharply rising incomes. The Mortgage Bankers Association and Washington Mutual aren't counting on either, warning investors to prepare for the real slowdown that is already taking shape.