THOMAS T. HAMMOND : Housing Market Make-Over : Lower Rates, Bigger Role for Mortgage Bankers Forecast

Since a federal law restructured the savings and loan industry in August, industry experts have debated its effect on mortgage interest rates.

Some have argued that S&Ls;, the major home lender nationwide, would raise loan rates and fees as they try to meet new requirements for higher capital levels.

Others have argued that competition from banks and mortgage companies would prevent S&Ls; from changing their rates much.

Thomas T. Hammond figures the era of the mortgage banker is upon us, and that S&Ls; no longer enter into the home loan equation.

As chairman and president of the Hammond Co., a Newport Beach mortgage banking firm operating in four states, Hammond sees some new trends in the mortgage and housing markets.

Hammond is an outspoken industry executive who has wrangled with S&L; regulators during his aborted effort to buy a Riverside thrift last year. He also is keeping an eye on Fidelity National Financial Inc., an Irvine title insurer that has been gobbling up so much Hammond Co. stock that it has become the second-largest shareholder with a 23.6% stake.

In an interview last week with Times staff writer James S. Granelli, Hammond discussed what he believes is happening in Orange County’s mortgage and housing markets.

Q. In what direction are mortgage rates likely to go in the next few months?

A. Well, it’s difficult to forecast interest rates, but I think in the intermediate term, say, to the end of the first quarter, rates are going lower. But it appears there’s a very good bull market in bonds--in the 30-year fixed mortgage markets--so I expect rates will be sliding down a little.

Q. Under the S&L; bailout bill, mortgage companies were expected to turn up the heat, forcing savings and loans to hold mortgage rates down, or, at least, not increase them very much. Has that happened?

A. It’s beginning to happen. You have to understand that mortgage bankers have had between 25% and 35% of the residential loan origination market in this country. During the last five years, until the bailout bill, mortgage bankers have had a tougher road. Their share of the market dropped because the thrifts could lend money--and did lend money--without regard to capital market rates, without regard to what they were going to do with these assets and without regard to their net worth requirements. That explained why the thrifts dramatically increased their assets over the past five or six years. It was their attempt to get well. Obviously the plan failed. Now they’re in a retrenching situation.

Q. So now you’re gaining the upper hand.

A. As the mortgage industry starts coming closer together with respect to rates, mortgage bankers have a distinct advantage. As a mortgage banker, I consider our primary competition in the next period of time not to be the thrifts--they’re done and gone, with respect to being competitors of ours--but the commercial banks. Just this past quarter, for the first time in a long time, the commercial banks originated more mortgages than the thrifts. So the commercial banks are going into the mortgage business in a big way. In fact, our company now finds itself selling to some of these major commercial banks. But it’s our time now, and I think our share of the market has gone up in the past year, and I think it will continue to increase.

Q. How much?

A. Well, we’ll probably get up to 35% or 40% of the market.

Q. Is your competition from commercial banks coming mainly from the large banks or from the local banks?

A. Bank of America, Citicorp, Chase Manhattan. They are the players today.

Q. Didn’t the bailout law affect mortgage rates by rather quickly moving them up?

A. Yes it did. There was an immediate impact when it became clear that thrifts would need much more capital. It was interesting that the big California lenders were the dominant ARM (adjustable-rate mortgage) lenders and were really succeeding because of teaser (introductory) rates and fees. They were killing the rest of the industry, dominating it. The minute it became clear what the capital requirements for S&Ls; were going to be, they knew they were not going to be able to sell these below market mortgages. They instantly raised their rates and fees. That put them in an extreme competitive position with everybody else. This was certainly the case with Home Savings and, to some extent, Great Western and the other major thrifts that were the power players in the teaser rate ARM business.

Q. There doesn’t seem to be such a thing as teaser rates any more. Aren’t introductory rates for adjustable-rate mortgages almost the same as fixed rates right now?

A. Yes. We can’t sell an ARM loan. I don’t think last month that we did more than a handful of ARM loans, and I don’t know why we did those. They’re not competitive.

Q. Is the lack of low teaser rates a major reason for the slowdown in buying?

A. I think not. Housing cycles have definite characteristics. One must remember that from 1980 to 1985 we had very little new supply of housing coming on the market. The people who did avail themselves to housing during that period, both new and resale, were buried in high-rate loans. They really needed to buy a house. There was a move or some compelling reason. The discretionary buyer left the market during that period of time. Interest rates fell dramatically beginning in 1986. And we had a tremendous pent-up demand from people who hadn’t made a housing decision for four years. Plus, we had a whole group of families buried in high-rate mortgages. So, 1987 was the highest year ever for residential mortgages. It’s the only time America has had $450 billion in mortgages. This year we’ll do somewhere between $325 billion and $350 billion, to give you an indication.

Q. So we created a tremendous housing boom.

A. Yes. We had this pent-up demand, plus we’ve had a very strong California economy--new jobs, new migration, immigration, Pacific Rim business and so forth. It appears to me now that two things have happened. We’ve sort of satisfied the demand and the economic job creation that’s been going on is still going on, but not at the accelerated rate we have had in the past three years. So this housing boom may be maturing, and that’s part of a normal process. I don’t think it’s going to collapse and I don’t think it’s going to become as bad as ‘82, ‘83, ’84. But it certainly has matured and it’s running out of steam.

Q. If adjustable loans were used in the last five years to make it easier for people to qualify for loans, is it harder now?

A. You have to understand the way the balance sheet of the typical American family has changed over the past five years. I’m not sure it’s harder. It’s just the reflection of the new realities of what a family’s financial situation is today. Those basic changes are that it’s almost unusual today that we have a family with a single income. We have two incomes in every household--that’s almost universal. The second thing that we’ve found--and we operate in four states and we do between 300 and 500 single-family home loans a month--is that 30% of all of our loans have non-married co-borrowers; that is, people cannot afford these houses without a parent, an uncle, a friend or somebody else coming into the deal. I would say that five years ago, we would not have had 5% of our mortgages like this.

Q. So the loss of teaser rates isn’t affecting home buyers’ ability to qualify for loans?

A. Perhaps. Housing is taking on different aspects and characteristics than it has in previous periods. The ARM business--the cheap teaser rate business--allowed people over the last four or five years to get into housing they otherwise could not afford. This was just another way of the lending industry turning its back on underwriting. It was just a rationalization to get more business. In some regions of the country, it’s been an economic disaster because the people who qualified on teaser rates have turned out to be unable to pay at higher rates. What we really should be concerned about is that there’s a general deflation under way.

Q. Aren’t some places going down in value already?

A. In California, we have a very odd situation. It’s hard to say whether our prices have leveled or are falling. Between 1981 and ‘83-’84 we did have very definitive deflation in housing. It caused tremendous delinquencies, previously unheard of in California. I don’t think we’re to that stage yet, but we certainly have been through it before and we’re seeing symptoms on the East Coast now, certainly in the Southwest, certainly in many parts of the Midwest. We’re seeing tremendous problems in Arizona--real genuine deflation going on there with falling house prices.

Q. Even in California, there are reports of home prices declining. Are prices able to fall without genuine concern over deflation?

A. This is the way I would characterize it. In Orange County, August last year to August this year, the number of new and resale houses sold, according to your paper, is down 28%. That’s a significant drop. As I recall, the ’87 to ’88 numbers were down 16%. So we’ve had two years of declining units despite this seemingly extraordinary housing boom. What’s happening is that we have an imbalance in the housing market. What we’ve really enjoyed is a new-home sales boom.

Q. What do you mean?

A. Prices in the resale markets in Orange County and most areas of Southern California are much lower than in the new home market for a couple of reasons. As we’ve developed this tremendous economy in Southern California, we’ve developed affordability bands. If you have a house listed today in Orange County in any reasonable area at, say, $200,000 or below, the market is fairly brisk. If you’re in the $250,000 to $400,000 range, we are accumulating inventory at the moment. The higher end of the market, above $400,000, always seems to have a life of its own. It sort of defies trends.

Q. Have housing prices peaked right now?

A. At this point, I think we have brought just enough product to the market. I think we’ve sort of met supply and demand. If we keep bringing new $350,000 houses on the market in South Orange County at the rate we have for the past three years, yes, we will have surplus supply and we will have some softening. In fact, we’re now figuring out ways to help our builder customers subsidize mortgages to get people into homes at these higher prices. That is the biggest product we are selling right now.

Q. Could you explain that product?

A. People all want 30-year fixed loans today. So builders will prepay interest to lenders to provide mortgages that will have, say, a 2-percentage-point lower interest rate for the first year, then 1 point lower for the second year and so on. There’s a variety of combinations that they use, but it’s a discount they offer to people to buy their houses.

Q. Aren’t the builders just asking more for the houses to cover the discounts?

A. One never knows if that’s coming out of their profit or they’re raising the prices to get it back.

Q. Rather than moving, are people refinancing or taking out home equity loans to put on additions or refurbish their current homes? And are we seeing people sell their homes, buy lower-priced homes and put the difference into remodeling the new homes?

A. Yes. Absolutely. What is unique about the ’88 and ’89 housing cycle is that we don’t have the house flipping that we used to have. Families used to pack up and move for a school district, for an extra bedroom or whatever. They would move up. We’re not seeing that now because we’ve had this extraordinary inflation.

Q. And moving usually means buyers will pay higher taxes too.

A. Yes. We have this damnable Proposition 13 tax (limitation) situation that is now a deterrent to moving. It used to be when your house inflated 20%, the difference in your property taxes was not a driving motivation. When your house is now worth 100% more than when you bought it, you’re facing a major monthly cost increase if you sell and move. And that has now put a bite on families. Families will settle down and expand their houses. They all of a sudden get content with their local school districts. They’re not moving. We used to think in terms of a 3-to-1 new market to resale market. Three resales for every new house. That is stretching out now, because people are not moving up.

Q. What do you think the ratio is now--5 or 6 to one?

A. It’s approaching that. Just look at the realty board statistics in our communities in Orange County that are reported every Sunday in your paper and you’ll see that these numbers are not like they were. And there are more people and more houses and more housing stock in these communities. The number of resales is declining despite an increase in housing stock.

Q. Developers would say their costs are rising faster, causing this wide gap between new and resale house prices. Is that a major factor?

A. Of course it is. But, and I’m not going to become political, it’s becoming apparent that one of the worst things we did was enact this Proposition 13, and the irony is that builders and Realtors were real advocates of it. But now what’s happened is that we’ve reorganized our tax base in this state. And the local communities and the local school districts are scrambling for revenues. They do not have the revenue base to provide the infrastructure to allow these communities to grow. So the result is that if the community wants to expand, it must sock the new home buyers--they’re not socking the builders--with the cost of this infrastructure. The municipalities have been permanently impaired by this tax limitation. There’s going to be more and more awareness of this problem.

Q. You think we’ll see a Prop. 13 change some day?

A. Absolutely. We must.