A slowdown in the housing market will be a headwind to banks' loan growth, but industry observers do not expect weakness to spark notable credit issues for banks.
Higher interest rates and elevated inflation have made homes less affordable and slowed sales activity, prompting concerns that home prices could decline from frothy levels recorded during the COVID-19 pandemic. Weaker sales activity will also reverse the sizable boost that banks recorded from mortgage banking operations in 2021, and declines in home prices could cause credit pressures.
Banks are not, however, expected to record much stress in their loan portfolios and have seen few credit issues so far, industry experts said.
"We have started to see a little bit of a rise in delinquency rates, but they are still quite low by historical standards," Nancy Vanden Houten, lead U.S. economist at Oxford Economics, said in an interview.
The Mortgage Bankers Association reported a seasonally adjusted delinquency rate for mortgage loans on one- to four-unit residential properties of 3.64% at the end of the second quarter — the lowest level since the association started its survey in 1979. Construction loan delinquencies rose in the quarter, however, by 20.9% sequentially and by 10.9% year over year.
Banks are preparing for credit to worsen. Most banks that expect to tighten standards cited anticipated deterioration in borrowers' capacity for debt-servicing due to factors including inflation, the risk of inflation, falling collateral values or credit quality of loan portfolios, according to the Federal Reserve's July 2022 Senior Loan Officer Opinion Survey. Another of the most-cited reasons was greater exposure to interest rate risk because of inflation or inflation risk.
Still, observers say the impact is likely to be limited.
"I don't think we're going to see a big spike in losses unless unemployment in the country skyrockets, and that doesn't seem very likely," Jeff Davis, managing director of the financial institutions group at Mercer Capital, said in an interview.
Lower supply supported prices
The housing market was white hot in recent years, but sales have slowed, and median sale prices have dipped from the recent peak in April, according to data from the Census Bureau. The median sale price, not seasonally adjusted, was $439,400, up from $406,000 in 2021.
Vanden Houten said home prices rose because of historically low supply, especially in the existing home market, unlike before the 2008 financial crisis when home values rose largely because of lax lending. Construction has added to new home supply, but builders are worried that buyers will not be able to afford their properties, Vanden Houten added.
Housing supply, as measured by existing supply on the market, rose to its highest level in more than a decade in recent months as new purchases collapsed. The Census Bureau reported in July that there were 10.9 months of supply on the market on a seasonally adjusted basis, up from 9.2 months in June and just 6.0 months a year earlier as sales activity slowed. But even after its recent rise, supply remains below historical averages because of years of underbuilding relative to demand.
Whether low supply will bolster falling prices depends on the area, Davis said. That pattern applies in areas such as Phoenix; Dallas; Houston; Atlanta; Nashville, Tenn.; and Charlotte, N.C. But the trends will differ in areas such as Cleveland, Detroit and Chicago, potentially because they are already relatively affordable, so prices do not have as far to fall.
Mortgage banking decline
Mortgage banking boomed over the last couple of years. But originations — especially refinancings — have cratered amid substantial increases in long-term interest rates and a corresponding increase in mortgage rates.
"There's no mortgages to refinance to speak of, and Americans have come to their senses, I suppose, and aren't paying or not as willing to pay exorbitant prices for homes," Davis said.
Nonbanks have taken a share of the origination market from traditional banks in recent years, leaving banks less vulnerable to mortgage market declines.
"There are a lot of nonbank originators who have captured the biggest share in the origination market," Sandeep Bordia, head of research and analytics at The Amherst Group LLC, said in an interview. "So I don't think you're looking at as many job losses at banks as you would have historically expected with this kind of origination volume decline."
Among U.S. commercial banks, one- to four-family loans 30 to 89 days past due and more than 90 days past due both declined in the second quarter, sequentially and year over year. Past-due and nonaccrual loans at U.S. commercial banks were 1.92% of the total of one- to four-family loans as of the end of the second quarter, according to S&P Global Market Intelligence data.
Ancillary impacts
Construction loans are still growing, with residential construction loans at U.S. commercial banks up 18.4% year over year and nonresidential construction loans up 6.7% year over year in the second quarter,
Richard Martin, director of real estate lending solutions at Curinos, said builders are operating cautiously and finding that they need to offer discounts to unload inventory.
"It's not like we're keeping pace with demand, even though demand's cooled off with the increase in rates and some people just frankly being priced out or unable to afford," Martin said.
Builders appear to have slowed new development in recent months. Housing starts in July were 12.6% below the second-quarter average, 15.9% below the first-quarter average and 9.1% below the second-quarter 2021 average, according to U.S. Census Bureau data.
Mercer Capital's Davis does not anticipate significant effects on jobs within mortgage banking or other industries impacted by the housing market. Davis also does not believe that banks are likely to record a spike in losses on mortgages made during the recent housing boom.
Davis acknowledged, however, that a slowdown in housing could become a future headwind to construction lending and said it would likely take a year or two for construction balances to fall as builders slow down the pace of building.
"Barring an '08 event, the houses will be sold," Davis said. "It just may be that the builders are not going to make as much money, or they may end up losing some money. But that'll clear out off bank balance sheets, and then if the housing market stays very slow, it's just going to be a business line that is very subdued."