Of all the things that went wrong during the financial crisis, the housing and mortgage markets have taken the longest to recover. But now, some positive signs in mortgage financing are bolstering the argument that for real estate, the worst is truly over.
The good news comes from what's known as the jumbo mortgage segment. For a while last year, few if any lenders were making this kind of loan. Now, Wells Fargo (NYSE: WFC ) , US Bancorp (NYSE: USB ) , and Bank of America (NYSE: BAC ) have increased their activity in making jumbo loans, according to Marketwatch.
To understand why this is good news, you need to understand that the U.S. effectively has two separate mortgage markets. This segmentation relates to lenders' ability to resell mortgage loans to secondary buyers.
Throughout the housing boom, lenders resold many of the loans they originated to Fannie Mae (NYSE: FNM ) and Freddie Mac (NYSE: FRE ) . However, there are statutory limits on the size of mortgage that those government-sponsored entities can buy: currently, $417,000 for single-family homes throughout most of the country, with limits up to $729,750 for certain "high-cost" areas.
Throughout much of the housing boom, when the statutory limits were lower, many homes were too expensive for borrowers to qualify for "conforming loans" that met those limits. Especially before 2008, when the high-cost area limits were first established, it was nearly impossible to get conventional financing for homes in high-priced areas like California.
Because conforming loans are more widely available, mortgage rates tend to be lower for them than for jumbo loans, which cover mortgages that exceed Fannie's and Freddie's limits. Last week, for instance, 30-year jumbo rates averaged 5.8%, versus less than 5.1% for a conforming 30-year mortgage.
So even though these jumbo loans bear more risk -- a lender can't count on being able to resell a loan into the secondary market on demand -- there's also greater profit potential for banks that do a good job of finding safe borrowers. That's exactly the kind of incentive that many believe will stabilize the banking system. In addition, banks are being pickier about whom they lend to -- a welcome change from the go-go days when it seemed anyone could get a loan at any price.
Are nontoxic assets back?
Perhaps more surprisingly, the first issue of new privately issued mortgage-backed securities in two years happened last week. An affiliate of the real estate investment trust Redwood Trust (NYSE: RWT ) , which specializes in jumbo mortgage loans, issued $222.4 million in bonds. Underlying the securities were 255 mortgages written by Citigroup (NYSE: C ) , with a face value of $237.8 million. According to Bloomberg, the properties involved had a loan-to-value ratio of around 60%, meaning that roughly $400 million in real estate backs the mortgages.
The securities earned a AAA rating, and for once it looks like the rating agency might be right. With such a low loan-to-value ratio for the underlying mortgages, bond buyers have a lot of protection, even if home prices continue to decline. Moreover, real estate prices have already fallen considerably. Even if property values fall 40%, foreclosing on these mortgages would theoretically get back all the value for bondholders.
With a current yield of 3.75%, buyers aren't getting a huge reward for the risk they're taking on. But with minimal risk, the premium to Treasury yields may make the bonds worth it. More importantly for issuers like Redwood, getting any deal done revives the hope that the mortgage market can bounce back from a disastrous period in its history.
A good sign
These two pieces of news show that the mortgage market is breathing a sigh of relief. This time last month, many worried that the Fed's imminent exit from buying mortgage securities would presage a huge rise in interest rates. There was indeed a spike, but it was mostly short-lived. Given that the housing market will need a healthy source of financing in order to recover fully, signs of increasing stability in mortgage loans are good news for everyone.
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Millions made money during the housing boom, but who profited when real estate tanked? Read Morgan Housel's story of how Goldman Sachs ripped its clients' faces off.