David Olson

FOCUS ISSUE FOR THE WEEK: Adding the suppressed inventory of homes (5.5 to 7 million) on the market to the current 4 million for sale and you get a total of 9.5 to 11 million homes waiting to be sold. This could mean two years of inventory as opposed to a normal 4 month inventory/sales ratio. This excess will keep housing prices down for the next five years before it is cleared up and will force the Fed to keep interest rates low for at least the next two years. One forecaster (Scott Minerd of Guggenheim) sees the ten year Treasury slumping to 2.25% over this period. It has reached as low as 2.05% in late December 2008. Greenspan is concerned over another downward spiral in home prices if they fall another 5% or more which could lead to a fall in GDP. Correcting the housing market is the main economic need today.

MORTGAGE MARKET SUMMARY: The unemployment rate remained unchanged at 9.5% in July but otherwise there were more signs of weakness than strength for the week. There were 9 positive trends offset by 15 negative trends. The DJIA rose from 10,465 last week to 10,653. The major complaint of the industry was the huge and growing burden of compliance which has lengthened the process of originating loans and made it increasingly difficult for many homeowners to qualify for a mortgage.

Positive Trends

• The Commerce Department showed construction spending unexpectedly rose in June, boosted by a gain in government programs that made up for declines in private residential and commercial projects. The 0.1 percent increase in outlays followed a revised 1 percent drop in May that was larger than previously estimated.

• The interest rate for the ten year Treasury slipped to 2.82% on August 6 from 2.97% on Monday due to weak data on personal income and expenses in June and weak unemployment numbers. At the end of last week it was 2.91%.

• The Federal Reserve is giving serious consideration of resuming their support of the debt markets by purchasing MBS again given the slow growth in consumer income and spending. They are meeting on the issue next week.

• Earnings have topped analysts’ average estimates at 76 percent of S&P 500 companies that have released results since July 12, according to Bloomberg data on August 3.

• The biggest banks are adding government-backed mortgage bonds at the fastest pace in 18 months, breaking with an unusual pattern in which they shunned the debt as their loan portfolios shrank during the economic slump, according to Barclays Plc. Large U.S. commercial banks added $51.4 billion of so- called agency mortgage-backed securities in the two weeks ended July 21, according to the latest data released by the Federal Reserve. The holdings fell from $696.6 billion in the middle of 2009 to $687.2 billion on July 7 even as the lenders’ portfolios of Treasuries and agency corporate debt grew $104 billion. This suggests the large banks do not expect mortgage rates to rise very soon. The current spread of Fannie Mae securities over the ten year Treasury is 64 bp, up from a record low of 54 bp on July 30. This surge of demand means mortgage rates are likely to drop in the future and spread over Treasuries will remain narrow.

• Car sales rose 5.1% in July over a year ago according to Autodata Corp. The annual selling rate in July was 11.98 million vehicles, up 8.1% from 11.08 million in June of this year

• ADP estimated that U.S. firms added 42,000 jobs in July, more than the 30,000 earlier predicted. This is up from 19,000 new jobs last month. But this is still not enough to bring down the rate of unemployment. About 150,000 new jobs per month will be needed to achieve that goal. Over the past six months, monthly new hiring has averaged 37,000.

• The ISM servicing index rose to 54.3 in July, up from 53.0 in June.

• Freddie Mac reported that the average 30 YFR mortgage yield fell to another record low of 4.49% this past week, down from 4.54% the prior week. Despite continuing falling mortgage rates, the volume of mortgages is not increasing much at all. Underwriting has gotten so tight due to the plethora of new regulations and put-backs by Fannie and Freddie that very few home buyers can qualify. The average loan now has a 760 FICO and 30% down payment. Few can meet those requirements. Also, most lenders are so backlogged they are not interested in being aggressive with their pricing.

Negative Trends

• Nonfarm payrolls fell 131,000 in July which was lower than the 221,000 loss in June. Much of this loss was due to the loss of 60,000 census jobs. The private sector gained 71,000 jobs in July, up from 31,000 in June. This was lower than the 100,000 expected. This wasn’t large enough to lower the rate of unemployment which remained unchanged at 9.5%. The average work week rose to 34.2 hours in July, up from 34.1 hours in June.

• The Commerce Department reported that consumers saved 6.2% of their disposable income in 2Q10, up from 5.5% in 1Q10. This means consumer spending will not grow much in the near term.

• Bill Gross of PIMCO is bracing for a further decline in consumer prices. He said “the world is tipping toward deflation.” The CPI has been slowing down 0.1% for the past two years. The current level of inflation is around 1%, down from the Fed’s preferred target level of 1.5% to 2%. In June, the personal consumption expenditure index was up 1.4% year over year.

• The ISM index slowed down to 55.5 in July, down from 56.2 in June. This was the third monthly decline in a row. The index peaked in April at 60.4. The pace of broader economic expansion is moderating. The index for new factory orders slipped to 53.5 in July from 58.5 in June.

• The Conference Board expects GDP growth will slow to a 1.6% pace in the second half of this year.

• Personal income and personal expenses were flat in June, down from 0.3% for personal income and 0.1% for personal expenses in May. This is evidence of an economic slowdown.

• PCE core prices were also flat in June, down from 0.1% in May. This is evidence of deflation.

• Pending sales of existing U.S. homes fell 2.6% in June from May, reported the National Association of Realtors. Economists were projecting a gain for the month. The decline is blamed on the expiration of the tax cut on April 30.

• D.R. Horton Inc., the second-largest U.S. homebuilder by revenue, said today that orders for homes under contract fell 3 percent in the three months ended June 30 from the same period a year earlier. Horton said net income was $50.5 million in 2Q10 compared with a loss of $143.8 million a year earlier.

• Wall Street is not fulfilling many of its trades. In the week ended July 21, failures to deliver or receive mortgage debt totaled $1.34 trillion compared with a weekly average of $150 billion in the five years through 2009. This situation could drive investors out of the mortgage market. That means if the Fed starts buying MBS again to boost the mortgage market it will not be very successful.

• Inside Mortgage Finance reported total volume of mortgages was $320 billion in 1Q10 which suggests a $1.4 trillion market for 2010. The MBAA is still projecting $1.483 trillion for 2010 and reported $356 billion in 1Q10. They project the strongest quarter to be 2Q with $498 billion.

• A study by Alan Blinder and Mark Zandi estimates the ultimate price for saving Fannie Mae and Freddie Mac will be $305 billion compared to $138 billion for savings all other financial firms in this economic downturn. Fannie Mae posted a net loss of $1.2 billion for 2Q10 and requested an additional $1.5 billion from the government. This loss market the 12th consecutive loss for the firm.

• Personal bankruptcies rose to 137,698 in July, up 9% from June 2010 and up 9% from July 2009. This is the largest number in the past five years since Congress revamped the bankruptcy law.

• Initial claims for unemployment rose to 479,000 for the week ending July 31, up from 460,000 the prior week. This was much higher than expected by economists and shows that firings are continuing. Initial claims reached a three month high. Continuing claims were 4,537,000 in the week ending July 24, down from 4,571,000 the prior week.

• The FHA insurance pool is becoming depleted, and it only has $3.5 billion in cash and Treasury securities left in its “capital reserve account”. The money sitting in the CRA represents a 71% decline in just the last three months. The Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below its statutorily mandated threshold. On the good news side of the ledger, from October through June the FHA had 19,310 fewer insurance claims on loans gone bad and paid $3.7 billion less than projected by the audit, perhaps due to solid foreclosure efforts although some feel that this is only because some states are experiencing a backlog in processing foreclosures. The FHA Commissioner told FHA lenders that “Congress has taken quick action and passed H.R. 5981. (It has not been signed by the President yet.) The bill gives FHA the authority to adjust its annual mortgage insurance premium (from .55% to 1.55%), yielding approximately $300 million per month in value to the FHA Mutual Mortgage Insurance Fund at a time when its reserves are perilously low.” This came from the Rob Chrisman newsletter.

Conclusion

Despite the fact of record low mortgage rates, mortgage originations remain quite low and are not projected to exceed $1.5 trillion for the year. The rate of unemployment remained at 9.5% despite the low growth in private nonfarm payrolls. This suggests a continued high rate of unemployment and low rate of interest for some time. We expect both Congress and the Fed will attempt some form of stimulus soon.
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 reduce the challenges of delivering loans to multiple investors and thereby increase loan pull-through rates.