Wednesday, April 6, 2011

Building is Not in our Future

Yesterday afternoon, we received the disappointing but not entirely unexpected news that the Federal Appeals Court had denied NAIHP's and NAMB's request for a temporary restraining order and lifted the stay on the implementation of the Fed Rule on loan originator compensation.  So, today, April 6, the Fed Rule is in effect and all of us who are originating loans must comply with it or face the consequences (which are actually pretty severe.)

I don't think that the full impact of what this rule means will be understood for a long time, although we will begin experiencing some of the effects immediately.  The Fed Rule on loan originator compensation and the new qualified residential mortgages that the FDIC announced last week are going to dramatically change access to mortgage credit and lending in this country.  Today, I want to focus on one aspect of this long-term effect--the collapse of the residential home construction industry.

Home builders have been one of the many casualties of the housing crisis.   On March 24, the El Paso Times reprinted an Associated Press article entitled, "New Home Sales Lag to Half of 1963 Pace."   According to the article, "Americans are on track to buy fewer new homes than in any year since the government began keeping data almost a half a century ago. Sales are now just half the pace of 1963--even though there are 120 million more people in the United States now."  The Commerce Department reported that sales of new homes plunged in February to 250,000 annually, which was the third straight month of decline.  Part of the problem is competing foreclosures which are driving prices down, but part of the problem builders face right now is lack of access to capital.  The National Association of Home Builders is lobbying the House Financial Services Subcommittee on Financial Institutions to "open the flow of credit to home builders."  Of special concern to builders is the fact that their sources of lending are being cut off as lenders require additional equity, deny loan extensions, and make demands for immediate repayment on acquisition, development and construction loans.  The banks blame the banking examiners for their tough new stance towards builders. NAHB chairman Bob Nielsen says, "While federal banking regulators maintain that they are not encouraging institutions to stop making loans or to indiscriminately liquidate outstanding loans, reports from my fellow members and their lenders across the nation suggest that bank examiners in the field are adopting a much more aggressive position." These new lending pressures primarily hurt small, independent, local builders who cannot show enough cash to the bank to get the financing they need.

The builders' woes have spilled back into the general economy.  NAHB estimates that 1.4 million workers have lost their jobs in the construction industry which has led to a drop of $70 billion in wages.  NAHB further estimates that if we include the job losses of ancillary support industries who provided materials and services to the housing industry, those losses would total 3 million jobs and $145 billion in lost wages.  (That translates into the loss of a lot of tax revenue for a nation struggling to balance its budget.)  "NAHB estimates that over the next decade there will be a need for at least 1.7 million additional homes per year...This translates into five million jobs and significant economic activity. Without increased AD&C lending, this future demand will not be met, job loss will occur and job creation will suffer."

So what does any of this have to do with us as loan originators and the new regulations we are living under?  Plenty, actually.  For many years the major part of my business was one-time close construction loans.  The homeowner was actually able to get a loan to build his dream home on his own lot.  He hired a builder, took out the loan, and accepted responsibility for making the payments on the loan.  One-time close loans were a very popular vehicle for many very small builders, because they did not have to worry about trying to get the loan from the bank, or being stuck with a home after it was finished because the potential customer decided not to buy.  And they were also popular with customers, because the borrower had to qualify only once, at the beginning of the process, and therefore did not risk not qualifying for the home after it was built.

As the housing markets crashed, most wholesalers stopped doing one-time close loans.  I still have one lender who does offer them, and in fact we are brokering what is likely to be our final one-time close loan to them right now.  I say that because in this new world of regulatory reform, a one-time close is not likely to make the "qualified residential mortgage" list.  And for small independent originators like me, a QRM is the only type of mortgage we can originate since we cannot afford to retain 5% of the risk in a loan.  So consumers and builders will lose access to yet another source of funding offered by experienced, trained loan originators who can no longer offer the product.

In addition to the constraints posed by narrow definitions of "qualified residential mortgages" which FDIC chair Sheila Bair has already informed us are to be a "small slice of the market," builders and consumers alike are about to be confronted with another harsh reality of the implementation of the Fed Rule.  Construction loans, and in fact any type of difficult, work intensive loan, takes a lot of the loan originator's time and effort.  I see a number of different loan originator discussion forums, particularly those I participate in through Linked In, and I have been amazed to see the discussions from retail loan originators (not brokers mind you, but those working for banks and mortgage banks) about the types of work they are willing to do and not do as a response to the new rule.  For example, several participants in the forum said that they will no longer originate FHA 203K rehab loans.  The FHA 203 K rehab loan is a construction product which allows a borrower to purchase a home and finance substantial renovations to it in one loan.  The product is great because it allows a borrower to buy a distressed or foreclosed property and rehab it into the home they have always wanted.  And the financing vehicle can help employ people working in the construction renovation industries.

As an FHA loan, the 203K rehab should meet the "qualified residential mortgage" standards and therefore be available to any licensed originator.  But companies are planning to stop originating it anyway. Why?  Because construction lending is a lot of work and very time consuming.  When an originator's pay cannot vary from transaction to transaction, he or she does not have any incentive to work on more difficult loans or take on complex assignments.  In fact, the originator is being paid exactly the same for each loan whether it is easy or difficult, so he or she has incentive only to offer the loans that he/she can close the fastest with the least amount of work.  So a perfectly good financing vehicle is about to fall by the wayside because it the compensation received does not justify the work involved. 

I have thought a lot about the loss of construction lending in the past few days because I am working on getting my brother's house sold in the community of Santa Teresa, New Mexico. Nearly six years ago, when my brother and his family moved to Santa Teresa, the community was supposed to be on the verge of a boom.  A billionaire developer had just announced plans to expand the small community and to build it up to rival Scottsdale, Arizona.  The developer opened a mortgage company here to assist with the mortgage applications and was working with the State government of New Mexico to get some concessions for his project.  After a couple of years, though, the housing crash came, the concessions were never made, the billionaire moved to Houston and closed his development company and his mortgage company.  Santa Teresa remained exactly as it had been for the past twenty years--a very small residential community of mostly upper middle class families.

Then, this week, all of that changed when the new governor, Susana Martinez, came here and signed a repeal of the locomotive fuel tax.  Apparently, Union Pacific had planned to put a HUB in the Sunland Park/ Santa Teresa area for years, but they had never gone forward because the previous governor would not sign the fuel tax repeal.  Now, with the repeal signed into law, Union Pacific is ready to go forward with their new HUB, which will bring 3000 jobs to the area by 2015 and 600 permanent jobs after that.

I could not help shaking my head at the irony.  Not only is the billionaire developer and his development and mortgage companies long gone, but the new Fed Rule will force the break up of affiliated business arrangements between developers and mortgage companies or builders and mortgage companies.  So a builder wanting to go into Santa Teresa now would not be able to be affiliated with the mortgage company doing the transactions.  With one-time closes almost a thing of the past, and very little construction lending happening through the community banks, builders are not going to be able to build the homes to support the jobs that are coming. (Unless they can find a new billionaire to finance the project, the odds of getting AC&D funds are small.)  And the community definitely does not have housing for 600 additional people now.  So the new employees of Union Pacific will probably have to succumb to one of three choices: 1. Live in El Paso where they can pay very high property taxes from Texas, in addition to paying the state income tax required by New Mexico, 2. Buy homes thirty miles away in Las Cruces and commute, 3. Pay a lot to buy an existing home in Santa Teresa for the privilege of living close to work.

That's good news for my brother, but not such good news for the new residents of the area, or the builders who could build homes on the ample land available in the community if they just had access to some credit. It is also not good news for the unemployed people in our area with construction backgrounds who could finally have plenty of work again if they had a home builder to hire them to build hundreds of homes.  All of these people are just another set of casualties of financial reform.

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  1. Unfortunately the builders are a victim of their own success… or maybe a better word would be 'excess'.

    In the majority of markets there are too many homes. Last I heard there are 19 million vacant homes around the country. 19 million!

    Over the past 10 years homebuilders became ‘intoxicated’ on easy business and easy credit. Now they are experiencing the cosmic ‘hangover’ just like Joe Consumer.

    Regulators and credit aside... this problem is simple supply and demand.

  2. Amazing post!! And yes builders have the same situation right now.I liked the poem on the comments :). And this is a great blog I have gone through all posts.

  3. Thanks very much for the kind comments.