Sorry, that loan program is gone

Posted at April 18, 2023 Posted In Equity Insights Newsletter

“What!?! You’re NOT funding ANY of my locked loans!?!”

True story, this really happened to us. Lights out in a matter of moments.

This happened during the 2007 credit crisis. It didn’t take long for house prices to begin to reflect the disaster. Unlike credit markets though, real estate moves slowly.

The current banking upheaval has seasoned lenders spooked so let’s take a deeper look. Afterall …

Real estate demand is directly linked to the availability of mortgage lending.

One of the primary concerns in lending today is the potential for a severe credit crunch, which could have a significant impact on mortgage lending.

What’s a Credit Crunch?

Before we delve into the potential impact of the current banking crisis on mortgage lending, it’s essential to understand what a credit crunch is. Essentially, a “credit crunch” or “credit squeeze” occurs when lenders become reluctant to lend money, either because they are concerned about the creditworthiness of borrowers or because they do not have sufficient funds available.

A credit crunch can occur for a variety of reasons. For example, if there is a significant downturn in the economy (or anticipated downturn), lenders may become hesitant to lend money to businesses or individuals they perceive as high-risk. If there is a significant financial crisis, such as deposits fleeing or banks’ reserves and/or access to funding being squeezed, banks may find themselves with insufficient funds to lend, which can lead to a credit crunch.

How the Current Banking Crisis Could Lead to a Credit Crunch

The current banking crisis is primarily centered around issues related to banks owning long term bonds with low-yields as the Fed is on a rate hiking tear. With the Fed Funds Rate rising nearly 500% in a single year, the value of these bond holdings has been crushed (value being inverse to yields). No big deal if the banks don’t have to realize these losses in value.

Realization setting in … With the collapse of Silicon Valley Bank and Signature, the world woke up to just how illiquid and exposed the banking system is. Fears of deposits being at risk only exacerbated the “run on the bank” contagion, especially in small local banks that may not be supported by the widely implied and accepted “too big to fail” mandate. Deposit withdrawals trigger a draw down from their reserves and the need to raise liquid capital to meet these depositor demands. Even large banks need to allocate funds to rescue other banks to keep their confidence con-game going (ex. Big Banks Create $30B Rescue Package). So, what’s a bank to do?

Bank choices for raising capital …

  • Sell assets? At a loss (remember their assets offer yields scarcely marketable at today’s going rates). Not good.
  • Borrow from other banks or the Fed (like BTFP special lending facility)? At higher interest rates (net interest margins are squeezed). Not good.
  • Raise additional deposits? Paying depositors higher interest (to compete with Treasuries offering higher yields). Not good.

Simply put, the credit crunch is underway. Not a lot of good options. And if banks borrow at higher costs to patch liquidity, where will they safely lend at higher yields to increase margins again? And this is assuming that after meeting increased depositor demands and covering losses from asset sales and CRE defaults that they have much excess to lend? We’ll have to shelf that topic for a future time.

How a Credit Crunch Impacts Mortgage Lending

Just like an individual that is in a liquidity crunch and hoarding reserves, banks will become hesitant to lend money. They may tighten their lending criteria and become more picky on who and what they’ll lend on. Here’s what the banks are saying …

Change in Percentage of Increased Tightening Standards for Domestic Banks (by categories, since Q3 2021)

Credit availability is tightening, but not in all categories equally.

There’s a clear winner! The mortgages backed by the guarantees of the GSE’s (Fannie Mae & Freddie Mac) are not seeing much tightening (only up 1.8%). While the Mortgage Bankers Association is showing overall tightening as well, the moves are modest so far.

As feet-on-the-street conventional mortgage originators, here’s what we are seeing …

  • Generally Higher Credit Spreads & Interest Rates – The spread between the 10-yr Treasury yield and the 30-yr Mortgage rate is substantially above historical averages.
  • No More HELOCS on Investment Property – Since the extremely high 9.1% CPI number released in the summer of 2022, we’ve seen lenders stop offering HELOCS on investment properties.
  • High “Risk-Adjusters” on Investment Property & Second Homes – Especially on high loan-to-values and cash-out transactions, the loan-level price adjusters are hitting hard for these loans.
  • Sweet Spot for First Time Home Buyers! – Reduced price adjusters for lower-credit score borrowers and better rates (relatively speaking) for lower down payments buyers. We’ll circle back to opportunities here in future writings.

Strategic Moves to Consider

In summary, a credit crunch can lead to higher interest rates and less ability to get financing because of increased costs for banks, decreased supply of available capital, and concerns about the economy and the borrowers’ ability to service their debt in the future. Higher interest rates make it more difficult for borrowers to qualify for loans and service their debt, further exacerbating the credit crunch. When things spiral out of control too quickly, history says the Fed steps back in to prop things up again. But the journey to that point is not a walk in the park and should be respected.

Take It While You Can Get It

If you’re on the fence about obtaining financing today (because of “high” mortgage rates) and you have a good plan to service the new debt, don’t delay.

It’s possible that as this credit crunch picks up steam the loan programs you’re thinking about leveraging in the future, are not available for a period of time. Or a rise in unemployment hits home for you and a change in income source means even the loan programs available, you don’t qualify for anymore.

Remember HELOC’s are Fickle

Home Equity Lines of Credit are open credit lines that are available to you, but are not guaranteed to be available to you in the future. The bank could decide economic conditions merit shutting off the line to reduce their exposure to risk. What is already drawn cannot be called due and payable (unless you’re in default), but what is not drawn yet can be instantly unavailable. If you have an existing HELOC with caps keeping the cost relatively low, consider drawing in full.

Get In Position to Be a Prime Borrower

As capital seeks secure investments during times of turmoil … Be a safe bet. Make sure you’re doing all you can to boost your credit score. Consider the impact of each financial move on your borrowing power. If you’re married, choose wisely who signs for what liabilities. If you’re self-employed, carefully analyze each tax return to make sure you’re reporting income and expenses in a way to maximize your lend-ability.

Let Us Help You

As you’re contemplating financing moves and working to maximize your future lend-ability, reach out to us for input. We’ll help you understand how various decisions (like your tax reporting, asset protection, consumer credit) will affect your strength in the eyes of lenders.

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