By Robert Brannum
After three solid years of performance, the United States economy slowed in 2007. It’s hardly surprising when you consider the Federal Reserve Bank had issued 17 consecutive rate hikes before this year. Upon closer examination, it’s really the housing market that’s taken a hit to the chin; according to Standard & Poor’s (S&P), excluding the housing market, the rest of the economy has actually grown close to 3 percent.
What is the economic outlook for banks, and specifically New York banks? This economic under-performance certainly hits banks where they live – in their lending, investment banking and trading businesses. S&P projects that 2008 will include significant remaining bank loan and mortgage-related securities markdowns, and that investment banking and trading departments will suffer earnings reductions as a result of the economic rollercoaster we’ve been riding.
In the lending business, housing starts are down across the country and mortgage loan originations have slowed. In general, market conditions for the mortgage finance industry are unfavorable at both extremes of the market: the high-end jumbo loans and the lower-end subprime loans. The banks’ challenge is the pricing of prime jumbo loans, as well as the lower volumes and weak credit in the subprime market. Those institutions that are likely to be highly exposed are specialty mortgage finance companies and retail banks that are highly reliant on their mortgage businesses for earnings. With national home prices projected to decline 11 percent through the end of 2008, and millions of low adjustable rate mortgage interest rates scheduled to reset to higher rates, there is no doubt that many bank customers – the consumers – will be negatively impacted across the country.
President Bush’s plan with the mortgage industry to stem foreclosures by suspending those increases on subprime loans is still to be tested; and it only impacts those currently in good standing with their lenders, not those who are currently behind.
Impact on New York State
New York state is in a position to see less-than-average declines. Unlike Michigan, whose economy is in recession, and to a lesser extent California, Florida, Arizona, Nevada Ohio and Indiana, whose economies have slowed, New York has maintained its relative strength.
However, third quarter reports from the New York State Banking Department indicated that New York residents did experience economic pressure from several sides:
- Unemployment rates rose between the second and third quarters;
- Personal income decreased between the first and second quarters;
- Personal bankruptcy filings increased, and
- Consumer confidence measures dipped after the spring season.
There are additional reasons to curb your enthusiasm: industry regulatory agencies indicate that 14 percent of N.Y.’s outstanding mortgage loans could be classified as subprime, and that 25 percent of 2006 owner-occupied one- to four-family properties were subprime; both figures are close to U.S. averages.
The state’s mortgage delinquency rates rose during 2007, and the number of homeowners with adjustable-rate subprime loans who were 90 days or more past due with payments, or who were already in foreclosure, rose significantly during the year. Foreclosure filings in New York state jumped to 5,498 in August, up 21.2 percent from the same period a year ago, according to figures released by RealtyTrac, an online marketplace for foreclosure properties. (Nationally, there were a total of 243,947 filings in August, up 115 percent from the same period a year earlier). According to a November speech by the State’s Banking Superintendent Richard Neiman, “New York City leads the state in foreclosure filings. In our rank of counties, the Bronx, Queens and Brooklyn are the top three counties for one- to four-family homes entering the foreclosure process. The filing rate in these boroughs is more than double the state average.”
Accentuate the Positive
Often accompanying business challenges are business solutions, and one area for expected optimism is in the bank technology area. In a survey conducted by Banking Systems & Technology magazine, industry executives have come to a consensus about where IT investments are expected to have the most impact on the business in the coming year.
Its survey of 140 banks, capital markets firms and insurance companies indicate that institutions are likely to spend more money in 2008 on technology than they did this year. Technology spending is expected to increase at institutions of all sizes. The largest spending increases appear to be at midsize banks – 60 percent of survey respondents in that category said they would increase their IT budgets by at least 11 percent to 30 percent.
Commenting on the survey, Celent Senior Analyst Jacob Jegher said, “Spending will be similar to trends over the last two or three years where we saw an average growth rate of about 4 percent, but it is moderate. My one concern with this moderate growth is whether banks will have much to invest in innovation, since they’ll have to invest more in regulatory/compliance and maintenance.”
Whatever bank budgets are earmarked for innovation, accompanying charts illustrate the highly ranked 2008 banking initiatives by institutional size. Regardless of bank size, clearly there are common themes of security, risk management, fraud and, to nobody’s surprise, improvements in lending technologies (see charts on opposite page).
On Nov. 15, the House of Representatives approved bipartisan legislation to reform mortgage and anti-predatory lending practices. This legislation (which still needs Senate review and approval) is titled “The Mortgage Reform and Anti-Predatory Lending Act of 2007” and is intended to establish a national standard to minimize foreclosures and to improving subprime lending practices while preserving working Americans’ access to consumer credit.
While the legislation is intended to have a wide-ranging impact affecting borrowers, landlords, tenants and the Wall Street firms that securitize loans, the largest impact is expected to be on banks and other mortgage loan originators.
If passed, this legislation would create a licensing system for residential mortgage loan originators. At the present time, there is no national standard for the licensing of mortgage originators. This proposed system for licensing and registration would require that mortgage originators be registered in a national database and meet minimum education and certification standards, similar to that required of securities brokers.
Mortgage originators will be required to provide full disclosures and present consumers with appropriate mortgages. This means that the originator will have the responsibility to ensure that a consumer who receives a mortgage loan has a reasonable ability to repay that loan.
What impacts will these licensing, registration and appropriateness requirements have on the typical bank?
“Actually, not very much,” according to Christine Pratt, research director at Financial Insights. “Banks have traditionally had strict credit guidelines that have essentially kept them out of these significant subprime problem loans.” The real impact, Pratt said, will fall on mortgage companies like New Century Financial Corp. and Countrywide Financial that relaxed their lending requirements” in order to become significant players in the subprime market. Said Pratt, “The impending legislation, in terms of licensing and lending appropriateness, should have little impact on banks.”
Robert Brannum is a freelance writer based in Boston with special expertise in the financial industry.