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TH E M R EP O RT | 39 O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T THE LATEST ORIGINATION Lenders Remain Bearish on Profit Margins Though lenders have maintained a net negative outlook on profit margins for the past seven quarters, that could be changing. T ight inventory and rising home prices are impact- ing demand for mortgage, and in turn affecting the outlook of mortgage lenders who reported a net negative outlook on profit margins for the seventh consecutive quarter, according to Fannie Mae's quarterly Mortgage Lender Sentiment Survey released in mid-June. While the overall outlook of lenders on profit margins stayed negative, the Q2 2018 survey found it was less negative than the first quarter of 2018. However, com- pared to the same period last year, the survey found lenders had become more negative on their profit margin outlook as "competi- tion from other lenders" remained the top driver for this view. "Lenders remain bearish this quarter as they continue to face headwinds from rising mortgage rates, tight supply, and strong home-price appreciation," said Doug Duncan, SVP and Chief Economist at Fannie Mae. "These factors have combined to squeeze mortgage origination volumes and have increased competitive pressures." Apart from "competition from lenders," market-trend changes continued to be the other key rea- son lenders cited for their lower profit-margin outlook. "Increased competitiveness will likely persist as a top driver of lenders' mortgage-business strat- egy," Duncan said. "We expect this will prompt businesses to turn to cost-cutting as a means of managing their bottom lines, with payroll reduction likely to assume a more prominent role in future belt-tightening efforts." In terms of demand from consumers for GSE-eligible and government loans, the survey revealed the share of lenders reporting growth in these areas over the last three months and expectations of growth over the next three, dropped to the lowest reading for any second-quarter period within the last three years. The reporting and outlook on demand for refinancing mort- gages didn't fare any better with more lenders reporting declining refinance demand in the first quarter—the lowest level reported since the second quarter of 2014. On the other hand, the net share of lenders reporting demand growth over the prior three months for non-GSE eligible loans hit a two-year high compared to the same quarter of last year. According to the survey, the net share of lenders reporting the easing of credit standards over the prior three months as well as the net share of lenders anticipating easing for the next three months remained stable. For nonGSE loans though, the net share reporting easing of credit standards ticked up from the first quarter, with the outlook on the net easing share for nonGSE- eligible loans reaching a survey high. Loan Defects Up Since 2017 Fraud, misrepresentation, and other loan defects increased slightly over the year this spring, but they have shown a significant decline since the introduction of the CFPB's "ability-to-repay" rules. T he frequency of loan defects, fraud, and misrepresentation in the information submitted in mortgage-loan applications remained flat over the month in April 2018 but increased slightly over April 2017, according to the Loan Application Defect Index, published by First American. First American's Loan Application Defect Index (LADI) "reflects estimated mortgage-loan defect rates over time, by geogra- phy and loan type," according to First American. The LADI held steady between March and April 2018, but increased slightly year- over-year, rising by 1.2 percent. The Defect Index for refinance transactions increased by 1.4 percent from March 2018 and was up 7.6 percent year-over-year. The Defect Index for purchase transac- tions, however, decreased by 2.2 percent month-over-month and in- creased 2.2 percent year-over-year. For a bit of longer-term per- spective, the Defect Index peaked in October 2013—since then, it has decreased by 19.6 percent. The five states demonstrating the greatest year-over-year increase in loan defects are Arkansas (+16.7 percent), Wyoming (+13.5 percent), New Mexico (+13.0 per- cent), Virginia (+12.2 percent), and Maryland (+10.8 percent). On the other end of the spectrum, South Carolina experienced the greatest year-over-year decrease (-13.3 percent), followed by Louisiana (-12.9 percent), Minnesota (-10.6 percent), Alabama (-10.0 percent), and Vermont (-9.6 percent). The report also examined the long-term impact of the "ability- to-repay" rules on loan defects in the years since. Implemented in January 2014 by the Consumer Financial Protection Bureau, the ability-to-repay rules is a new set of "requirements for mortgage lenders to carefully assess a consumer's abil- ity to repay their mortgage loan." "Since the ability-to-repay rules were issued, there has been a precipitous and significant decline in income-specific mortgage loan application misrepresenta- tion, defect, and fraud risk," Mark Fleming, Chief Economist for First American, said. "In fact, our income-specific metric within the Loan Application Defect Index reached its peak in December 2012, one month before the rules were issued. By September 2013, nine months later, the income-specific defect-risk metric declined 33 percent, as lenders implemented new loan manufacturing and underwriting practices in prepa- ration for the effective start of rule in January 2014. Since then, income-specific defect and fraud risk has continued to decline and is currently 70 percent below its peak prior to publication of the ability-to-repay rules." "Lenders remain bearish this quarter as they continue to face headwinds from rising mortgage rates, tight supply, and strong home-price appreciation." — Doug Duncan, SVP and Chief Economist, Fannie Mae