David Olson

FOCUS ISSUE FOR THE WEEK: The most dramatic economic news this week was the recovery of the stock market even though there was no big positive news released. By our count there were 13 negative trends offset by only 6 positive trends. The economy is still recovering but at a slow rate. The economy is encumbered by huge amounts of federal debt and increasing amounts of federal compliance that is very costly to business. Lending by banks is extraordinarily tight. The DJIA was 10,198 up 5.3% this week from 9,686 last week.

MORTGAGE MARKET SUMMARY: Mortgage rates hit an all time low for the third week in a row but tight underwriting is preventing originations from increasing very much.

Positive Trends

• Investors’ expectations of inflation fell to 1.8 percentage points at the end of June, down from 2.4 percentage points at the end of April as measured by the different in 10-year Treasury yields and 10-year Treasury inflation-protected securities.

• The American Bankers Association reported the total delinquency at banks on all forms of consumer debt has fallen to 2.98% in 2Q from 3.19% in 1Q and a peak of 3.35% in 2Q09.

• Apartment vacancies fell to 7.8% in 2Q10 down from 8.0% in 1Q10 reported Reis, Inc. The vacancy rate in 1Q10 was the highest in 30 years. Rents gained by 0.7% during 2Q10, the biggest quarterly gain in two years. The largest quarterly rent gains were in Long Island, San Jose, Boston, and Seattle. The biggest rent gain over the past year was in Washington DC. The addition of new apartment units to the market is expected to be 60,000 in 2012 and 2012 according to research Marcus & Millichap. It has averaged 100,000 to 150,000 per year over the past decade.

• The MBA reported a 7% increase in mortgage applications last week. Refinances were up 9% to the highest level since May 2009.

• Initial claims for unemployment fell to 454,000 during the week ending July 3. This was down from 475,000 the prior week. Continuing claims for unemployment fell to 4,413,000, down from 4,637,000 the prior week. But this decline reflects more benefit lapsing than pickup in hiring.

• Freddie Mac reported a third decline in weekly average rates for the 30 YFR mortgage. The yield fell to 4.57% from 4.58% the prior week. This rate is once again the lowest ever reported.

Negative Trends

• Office vacancy rates nationwide were 17.4% in June, the highest level since 1993. There was a decline of 1.8 million square feet in second quarter 2010 from first quarter according to Reis Inc. a research firm. There has been a decline in rented space since early 2008 which is an indication that firms aren’t planning to add staff. Average effective rents have declined to $22.01 a square foot a year, down from $25 in second quarter 2008.

• Homes in the foreclosure process sold at an average 27% discount in 1Q10 according to Realty Trac. Of all home transactions, 31% involved properties in distress. Home foreclosures set a record for the second straight month in May. Bank repossessions climbed 44% from a year ago and will probably set a record in 2Q10.

• Last week the BLS reported the unemployment rate fell in June to 9.5% from 9.7% in May. However, both the household and establishment surveys are based on small, incomplete samples subject to revisions as more data comes in. The unemployment rate could be 9.3% to 9.7% (with a 90% confidence level). Note that total employment fell 125,000 in June and the office vacancy rate increased which suggests deterioration in employment in June.

• Over the past four years the cost of compliance has soared causing lending standards to become very tight and profitability of lenders to diminish. According to Harvard’s Joint Center for Housing Studies, “87% of home purchase loans owned or guaranteed by Fannie Mae and Freddie Mac were made to borrowers with FICOs above 750 and original LTVs under 75%. Only 2% of their mortgages that were originated in 2006 met such standards.” We think it is this severe tightening of mortgage credit that is most to blame for the slow recovery of the economy. Spending more on fiscal stimulus with not make up for this tightening which has cut the vast majority of households out of the housing market. (“The State of the Nation’s Housing: 2010”, p. 22).

• The ISM index on service sector growth slipped to 53.8 in June from 55.4 in May. Any number over 50 represents expansion. This suggests the recovery is losing steam.

• Vacancies at large malls in the top 80 U.S. markets rose to 9% in the second quarter, up from 8.9% in first quarter according to Reis, Inc. Reis Inc. says the average vacancy rate won’t begin to decline until 2012.

• Total delinquency (30 days plus) on commercial real estate loans held by banks rose to 8.5% in 1Q10 from 8.2% in 4Q09. Many banks are giving borrowers more time to pay off their debts.

• Wells Fargo announced it is closing all 638 Wells Fargo Financial outlets across the U.S. These storefront outlets make consumer loans. The bank says “the economics of a separate Wells Fargo Financial channel are no longer viable.” This division is over 100 years old. This is following a national trend that has seen the closing of the consumer finance offices run by Household, Beneficial, Associates, etc.

• The ten year Treasury yield rose to 3.06% up from 2.98% last week

• The financial reform bill is likely to pass the Senate next week with a very close vote. The bill needs the support of at least two Republicans to secure the 60 votes necessary to block a filibuster. Potential Republicans are Collins of Maine, Snowe of Maine, Brown of Massachusetts, or Grassley of Iowa. A new amendment has been added called the Kanjorski Amendment which forms a council of ten financial regulators who can shut down a major financial institution if they pose systemic risk or it can make such institutions divest themselves of particular activities.

• The Federal Reserve reported that total consumer borrowing fell to $223.7 billion in May, down from $224.8 billion in April. Total consumer debt outstanding fell to $2.400 trillion, down from $2,407 trillion in April. Consumers are slowing down their debt which suggests they will be buying less in the future.

• A recent survey of economists by Bloomberg indicates they now project 2.8% growth in GDP over the next year and a peak in unemployment of 10.1% in October. This forecast is more pessimistic than last month’s survey.

• GM has given up the idea of buying Ally Bank. They have decided against creating their own finance unit and are instead talking with several large banks about bolstering their lending capacity.

Conclusion: Some recovery is occurring in Europe which is causing Treasury rates to rise here. Few economists foresee a double dip occurring but neither do they see strong recovery. We see much exodus from the mortgage industry with consolidation continuing to occur among the largest lenders. Smaller firms can’t afford the cost of compliance.
Originator Demographic Survey: Access Mortgage Research has launched a project to support mortgage brokers and bankers. The first step of this project is to measure the size and activity of current and former mortgage brokers and mortgage bankers. A second step is to derive a uniform way to deliver a mortgage loan to all investors and thereby increase loan pull-through rates. To participate in this survey, click onto: http://www.surveymonkey.com/s/June_Mortgage_Originator_Survey.
Future meetings run by Access Mortgage Research:
18th Benchmark Study Meeting for the Retail and Consumer Direct Channel – September, 2010 in Milwaukee.
18th Benchmark Study Meeting for the Broker Channel – Fall 2010
Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. We do customized reports from databases of mortgage lenders. For more details see www.accessmrc.com or phone 410-772-1161.