How the housing recovery is helping banks and title insurers, 1.22.13
Like Vladimir and Estragon, two aimless men waiting for the title character to arrive in the play Waiting for Godot, we’ve been patiently looking forward to the housing industry recovering since its bubble burst in 2007-2008. Now it seems our patience may be finally paying off.
As the housing sector continues to right itself, the market for mortgage loans and refinancings is picking up. Mortgage originations are forecast to rise 16% in 2013, according to the Mortgage Bankers Association. We think conditions should remain ripe for mortgage lending and refinancings, as banks wind down their deleveraging in the wake of the 2008-2009 financial collapse.
As fundamentals in the housing industry perk up, we think banks that are adept at mortgage loans and mortgage refinancings like Wells Fargo, First Republic Bank, EverBank Financial, and Texas Capital Bancshares, as well as companies like Fidelity National Financial that specialize in title insurance, should benefit.
Housing ticks upward
Just as you can’t talk about the original movie version of King Kong without mentioning Fay Wray, it’s hard to talk about the state of mortgage lending without referring to the health of the housing market. And right now that story is a positive one. Home building is on the rise – applications for building permits rose to 899,000 in November, the most since July 2008. And in a recent survey by the National Association of Home Builders and Wells Fargo, home-builder sentiment reached 47 points, a level not seen since 2006 and the eighth-straight monthly increase.
New-home sales are predicted to total 375,000 for 2012, 485,000 in 2013, and 640,000 in 2014 by Zelman & Associates, a real-estate research firm. Single-family housing starts are expected to swell from 375,000 in 2012 to 655,000 in 2014. And residential real-estate investment should grow to account for 3.5% of gross domestic product by 2015, up from 2.2% in 2011.
At the same time a decline in household formations has turned as sharply as the plot of an O. Henry short story. From 1997 to 2007 about 1.5 million households were formed annually in the United States. During the Great Recession from 2007 to 2010, that number dropped to about 500,000 annually. But in 2011 household formations rebounded to 1.1 million and are forecast to reach 1.3 million in 2013, according Freddie Mac, a government-sponsored organization that purchases and issues mortgage loans and securities. Household formations are rising as the unemployment rate drifts downward, increasing numbers of young people make more money and move out on their own, and the economy gradually improves. The key demographic group in household formations is people aged 25 to 34, who have regained more than 70% of the jobs they lost in the last recession, according to the ISI research group. In light of that, it should be no surprise that the outlook for housing starts is favorable in the near term.
Not all those 25- to 34-year-olds will be buying homes, of course. But we think most of them will be inclined to choose buying over renting, which is becoming less affordable. The average monthly apartment rent was $1,048 in the fourth quarter, a 0.6% increase from the previous quarter and a 3.5% increase from a year earlier, according to real-estate research firm Reis. It was the largest year-over-year increase in rents since 2007.
The difference between renting versus buying is most clear in the ratio of rent payments to mortgage payments. (A rent-to-mortgage ratio of more than 100% means that mortgages are more affordable than rents.) The ratio, according to Deutsche Bank, was 107.8% in the third quarter, the most recent quarter for which statistics are available. In contrast, the average since 1991 is 85%.
All of these improving numbers have helped push home prices steadily higher. The S&P/Case-Shiller Index rose 4.3% in October from a year earlier, up from September’s 3%. This was the sharpest annual gain since May 2010, when prices spiked due to an expiring federal tax credit for home purchases. And according to the National Association of Realtors, median sales prices reached $180,600 in November, the ninth consecutive month of year-over-year increases.
Rising prices: a first since 2007
Last year was the first since 2007 in which housing prices increased, and they are expected to continue rising. A recent survey of economists, real-estate experts, and investment strategists by housing site Zillow.com predicted selling prices would advance 1.3% by June 2013, 2.5% in 2014, 3% in 2015, and 3.3% in 2016.
The relationship between higher home prices and increasing home demand is a classic virtuous cycle: home buyers see prices rise, which motivates them to buy more quickly. They snap up empty homes and lower the inventory of homes available for purchase, thereby decreasing supply and boosting demand, which leads to . . . you guessed it, higher home prices.
What’s more, Federal Reserve Chairman Ben Bernanke has pledged to keep short-term interest rates low until two conditions are met: the unemployment rate declines to 6.5% (it’s currently 7.8%) and the inflation rate accelerates to 2.5% (it’s currently 2.2%). Plus, the Fed is committed to buying $40 billion of mortgage-backed securities monthly, further lowering mortgage rates. Low interest rates should help keep borrowing costs low for potential home buyers and encourage more borrowing, in our judgment.
Mortgage rates drop
So how have mortgage lenders responded to the revival in housing? At first, rather slowly. Over the past three years banks haven’t drastically changed their mortgage-lending standards. We think that’s understandable; after all, indiscriminate lending was part of what caused the sub-prime mortgage collapse that sunk the banks and the economy in 2008.
But the banks won’t be able to ignore, and aren’t ignoring, rising demand for mortgages for long. In a recent Federal Reserve survey of senior loan officers, the number of banks reporting increasing mortgage-loan demand was characterized as "significant". And mortgage-refinancing demand could be characterized as significant, too: 86% of current mortgage loans have a rate of more than 4.5%. That’s higher than current rates and should motivate borrowers to refinance.
Also, mortgage rates are falling for buyers of new and existing homes. Last July the average interest rate for a 30-year fixed mortgage reached an all-time low, 3.49%. Currently the 30-year rate averages 3.52%. As noted, we think such low rates should encourage more consumers to seek mortgages. Indeed, the value of mortgage loans for new homes is expected to grow from $503 billion in 2012 to $585 billion in 2013, a 16% increase, according to the Mortgage Bankers Association.
Lender profits rise
As demand for mortgages increases, lenders’ profits are climbing. Lenders made an average profit of $2,456 on each loan they made in the third quarter, up from $2,l52 in the second quarter, the Mortgage Bankers Association reports. The increase in profit was due to more home purchases and mortgage refinancings, as well as greater investor demand to own mortgage debt.
Of course, risks to the housing industry remain, including a still-sizable inventory of foreclosed properties and a large number of borrowers who are still "underwater" – that is, they owe more on their mortgages than their homes are worth. Lenders are petrified of loan buybacks: they fear that government-backed companies like Freddie Mac and Fannie Mae may require them to buy back a lot of loans if they turn sour. As a result lenders have tightened credit standards, which has tempered the expansion of mortgage lending.
Even so, we think mortgage lending should expand at a double-digit rate over the next 12 months. And we believe these four banks appear to be particularly well positioned to capitalize on that growth:
EverBank goes online
* EverBank Financial (headquarters: Jacksonville, market capitalization: about $1 billion) provides financial services that include money-market accounts, home-mortgage loans, and online banking. The company posted a 26% compound annual growth rate in assets from January 2007 to September 2012. Its total loans and leases generated amounted to $3.3 billion in the third quarter, an 89% year-over-year increase.
* First Republic Bank (headquarters: San Francisco, market capitalization: about $4 billion) offers banking and wealth-management services, with offices in 10 major metropolitan areas. During the third quarter First Republic sold $774 million of mostly longer term, fixed-rate home loans, recording net gains of $12.5 million. By comparison, in the previous quarter the company sold $436 million of loans with a net gain of $4.8 million.
* Texas Capital Bancshares (headquarters: Dallas, market capitalization: about $1 billion) is the holding company for Texas National Bank, which finances Texas-based businesses as well as individuals and families with a net worth of more than $1 million. The company holds more than $9 billion in assets, and its revenue has grown by 14% annually over the past three years.
Title insurers benefit, too
* Wells Fargo (headquarters: San Francisco, market capitalization: about $182 billion) is a well-managed, diversified financial-services company providing a variety of banking, insurance, investment, and mortgage-leasing services. The company’s mortgage lending climbed 56% year over year in November. Wells Fargo is the nation’s leading mortgage lender, with a small army of home-mortgage consultants (about 11, 700 strong). It processed $399 billion worth of mortgage loans in the first three quarters of 2012, and its earnings have grown for 11 straight quarters.
As noted, title-insurance companies are also getting a lift from the housing recovery. Title insurers protect homeowners against financial loss due to title mistakes, liens, and other problems. One title insurer that in our estimation has especially good prospects is Fidelity National Financial (headquarters: Jacksonville, market capitalization: about $5 billion). Fidelity is the nation’s largest title-insurance company, with a 34% market share. The company’s title-insurance revenue over the first three quarters of 2012 was $4 billion, more than $1 billion higher than that of its closest competitor.
In sum, a reinvigorated housing industry is generating a distinctly higher level of new business for mortgage lenders and title-insurance companies. We think that, unlike Vladimir and Estragon in Waiting for Godot, EverBank Financial, First Republic Bank, Texas Capital Bancshares, Wells Fargo, and Fidelity National Financial won’t have long to wait for growth, as the play that could be called the New American Housing Recovery enters its next act in 2013.
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Turner Investments, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm with more than $10 billion in assets under management in stocks, as of December 31, 2012. Turner manages growth, global/international, and alternative separately-managed accounts and mutual funds for institutions and individuals.
As of December 31, 2012, Turner held in client accounts 569,440 shares of EverBank Financial, 671,519 shares of Fidelity National Financial, 739,105 shares of First Republic Bank, 761,320 shares of Texas Capital Bancshares, and 119,950 shares of Wells Fargo.