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TH E M R EP O RT | 43 O R I G I NAT I O N S E R V I C I N G A NA LY T I C S S E C O N DA R Y M A R K E T ORIGINATION THE LATEST Banking Industry Begins Preparation for Higher Credit Costs Recovery and release period comes to a close, as experts predicted. T he U.S. banking indus- try's period of recov- ery and release have come to a close and as significantly higher credit costs loom ahead, financial institu - tions can expect a big impact on first quarter earnings. Fourth quarter 2015 data from the banking industry showed that the Kroll Bond Rating Agency (KBRA) was right about its previous predictions, which anticipated an end to the period of recovery and reserve releases for U.S. banks last year. As banks enter the first quarter of 2016, KBRA says the industry is entering a more normal period of building loan reserve levels for future losses, which suggests that significantly higher credit costs could lie ahead. "The era of virtuous perfor - mance of bank credit exposures almost perfectly coincides with the period of credit spread compression engineered by the Federal Open Market Committee (FOMC), begging the question as to whether we now face a sus - tained period of rising bank credit costs," KBRA stated. "Provisions for loan losses exceeded charge-offs for the first time in six years at the end of 2015. KBRA expects to see contin - ued increases in charge-offs and bank loan loss provisions as the year unfolds." According to the agency, the real estate industry may see increased incidences of charge-offs and non-current loans, but overall loan performance is projected to do well at banks. "It may be inevitable for bank credit costs to rise in the wake of the end of QE, but we do not expect that these increased credit costs will translate into lower credit ratings for banks in our coverage universe regardless of size," the report stated. KBRA also noted that loans secured by real estate of all asset types increased by 4.9 percent in Q 4 2015, with construction and development lending leading these gains. The report noted, "real estate credit conditions have been strong over the past few years, but face headwinds. In this regard, it is important for investors to understand that the performance of bank portfolios and similar asset-backed securities (ABS) asset classes are quite disparate and can even show negative correlations through the credit cycle." "It may be inevitable for bank credit costs to rise in the wake of the end of QE..." —Kroll Bond & Rating Agency Report Lenders Weigh in on Loosening Mortgage Standards Stagnant accessibility, rising refinance demands are on the horizon. F ewer mortgage lenders are reporting loosening credit standards, and many do not expect credit to become more accessible over the next few months. The share of mortgage lenders reporting easing credit standards over the prior three months fell for the second straight quarter, according to Fannie Mae's first quarter 2016 Mortgage Lender Sentiment Survey conducted in February. In addition, the survey also found that the share of lenders that expect credit standards to ease over the next three months decreased from last quarter for all mortgage types. Fannie Mae reported that 13 percent of lenders surveyed noted that credit standards eased over the last three months in the first quarter of 2016, down from 17 per - cent in the previous quarter. Over the next three months, 13 percent of lenders said credit standards will ease, down from 18 percent last quarter. Five percent of lenders said that credit tightened over the last three months, up from 4 per - cent last quarter. Only 7 percent of lenders said credit will tighten over the next three months, the same as last quarter. The survey also showed that more lenders reported that they expect to increase the percentage of their mortgage servicing rights (MSRs) sold to a third-party in the first quarter of 2016. More mid-size institutions expect to increase their share of MSRs sold to a third-party compared to the first quarter of 2015. Doug Duncan, SVP and chief economist at Fannie Mae, explained, "Lender expectations for easing over the next three months have also moderated. Many lenders also indicate a likely increase in the sales of mortgage servicing rights, possibly to com - pensate for these countervailing pressures on profits and to take advantage of current favorable pricing in the market." According to Fannie Mae, the net share of lenders reporting purchase mortgage demand for all loan types decreased significantly from a year ago, but lenders expect an uptick in refinance demand. The net share of lenders report - ing increased purchase mortgage demand for the prior three months declined significantly across all loan types from one year ago. Over the past three months, 39 percent of lenders reported a decline in refinance demand, com - pared to 42 percent last quarter. A total of 26 percent of lenders said that refinance demand increased over the last few months, up from 19 percent last quarter. For the next three months, 11 percent of lenders indicated that they expect refinance demand to decrease, down from 62 percent last quarters. Meanwhile, 50 percent expect to see an uptick in refinancing compared to 6 percent the previous quarter. "This quarter's Mortgage Lender Sentiment Survey results reflect recent market volatility. Lenders anticipate a pickup in refinance demand in light of the decline in interest rates this year, but report a slowdown in purchase demand perhaps because of a seasonal component," Duncan said.