Credit Union Management magazine’s Web-only “Loan Zone” column runs the fourth Thursday of every month.
It’s hard to overstate the impact that the volatility of the financial markets, ultimately caused by the mortgage and real estate meltdowns, has had on the U.S. economy. We all know that subprime mortgages, including stated-income loans, appear to be a thing of the past. Mortgage brokers are soon on their way to being extinct. However, over the last year I’ve challenged myself to dig deeper to get a better view of the future for credit unions and our lending operations. The damage done may extend far beyond the mortgage-backed security market and the overall economy.
House vs. home. I believe the damage to the housing market will impact how people think about owning a house for a generation or more. Owning a house used to be all about making a home. A life for you and your family. Somehow, over the last decade, owning a house became like buying and selling a short-term investment. If a stock goes down, a day-trader dumps it. If a house goes down in value now, people are dumping it or just walking away.
I expect a renewed emphasis on buying a home. What does that mean to a portion of the population—first-time homebuyers—that has been targeted by lenders and Realtors over the last decade to increase home ownership? Many of these people are single and told “now is the time to buy; homes are a great investment.” I think there will be an increase in the percentage of people who choose to rent because they’re not ready for a home, and they don’t believe in buying a house as a short-term investment.
Indeed, homeowners may want to look at their houses as homes first and as long-term investments second considering this recent upheaval in the real estate market. When long-term investors’ stocks go down, there are only “paper losses” until the stocks are sold. And it’s only if investors believe the stocks will continue to decline in the long run that they will sell.
Upscale housing. I’ve shared this story with a few of my colleagues over the last year or so as an example of how we often ignore warning signs. About a decade ago at my prior credit union, our senior management team reviewed an article that forecasted the slow decline in the upper end of the residential real estate market starting around 2011. The author’s theory was that the baby boomers, as they retired, would find themselves saddled with more debt than expected, and without the investment portfolios needed to sustain their lifestyles. The solution would be to sell their homes and downsize. In conjunction with their retirement, the next generation of potential home buyers would have neither the desire nor the financial ability to own a large, expensive home. That creates a market imbalance from having more buyers than sellers, exerting tremendous downward pressure on prices.
Fast forward to today. The upper end of the market had exploded in price and demand for a decade; now we understand that much of that growth was fueled by interest-only and stated-income loans. While spreads between conventional and jumbo financing have returned to close to historic levels, any home that requires jumbo financing is extraordinarily difficult to sell. The next generation of move-up buyers has seen the impact on high-end properties, and may be unwilling to make the financial commitment. Thus, I think this section of the market may not recover to pre-meltdown levels in the next generation.
It’s all about liquidity. The housing market has also shown that houses at all market levels are not the liquid investment people came to believe they were. In fact, houses can be rather difficult to sell, even in a low-interest-rate environment. As many sellers have realized, buyers have become ruthless in their pursuit of the perfect house at a perfect price. To some, it’s Karma at work, as sellers certainly had the upper hand for a decade or more.
One of the phenomena of this economy is that the housing market has impacted the ability for employers to attract out-of-market talent and for unemployed workers to relocate for a new job. The house has become a modern day albatross for these companies and job seekers. Will the next generation of home buyers have the desire to own a house that’s this illiquid? In a rapidly changing job market, the brightest minds may choose to rent or own a more modest home.
Delinquency and losses. Even as the economy improves, mortgage delinquency and losses may remain higher than what we experienced before the meltdown. The reason? I believe the rapid increase in prices allowed lenders to enjoy unsustainable levels of low losses. Consider this: Joe Smith, a homeowner, loses his job in 2012. If he had lost his job in 2002, Joe could have borrowed against his home, even being unemployed, with limited ability to repay. If Joe had faced an extended period of unemployment in 2002, he could have sold his home rather easily. Regardless of Joe’s options in 2002, he more than likely avoided a foreclosure. In the foreseeable future, consumers won’t be able to get an equity loan without satisfactory income and will have a tougher time selling. Thus, fewer options and a smaller financial safety net are available for the typical homeowner.
With unemployment projected to remain above 6 percent for the next five years, we are not out of the woods when it comes to mortgage portfolio performance. In the long term, I don’t see credit unions looking at mortgage lending quite the same again. In the past, credit unions sold fixed-rate, long-term mortgages for asset/liability management purposes. For the next decade, we might be selling mortgages deemed to be an undue credit risk, even with private mortgage insurance. To be honest, Ent isn’t waiting, we’re selling loans for credit quality purposes today.
How can we leverage all this change? Credit unions need to find a “new conventional wisdom.” Conventional wisdom dictated that we promote mortgage loans and home ownership when rates were low. The new conventional wisdom may be that the decision to buy a home is much more difficult. It’s now a decision that not only takes into account interest rates and recent home price trends, but a more subjective view of the member’s readiness to own a home. Does the member anticipate changing jobs in the next several years? Does she foresee some other aspect of her life changing? How much financial and lifestyle flexibility will she have if she hangs onto her cash and continues to rent?
Credit unions that figure out a way to add this type of consultative approach may not maximize their loan portfolios, but arguably, they will maximize member satisfaction.
The new conventional wisdom may change how we consider home ownership when it comes to the marketing of other financial services, including loans. For the career lenders out there, you’ll appreciate this viewpoint: If I had a dollar for every time I said, “This member is a home owner; they must be a good credit risk,” I could retire. Now, I really have to evaluate each applicant with a totally open mind without this kind of preconceived notion. Going forward, just because members are renters doesn’t mean they’re not prospects for investment products and other loans. We’ll have to do a better job of member segmentation, and be willing to experiment with campaigns geared toward a new generation of consumers—consumers who won’t consider their houses their primary investment because they don’t want to own one.
CUES member Bill Vogeney is SVP/chief lending officer for $2.9 billion Ent Federal Credit Union, Colorado Springs, Colo.