David Olson

FOCUS ISSUE FOR THE WEEK: We met with about 25 mortgage lenders at the MBA Secondary Conference in New York City this week.  The mood was pessimistic as these attendees expected only $800 billion in originations this year, down from $1.5 trillion last year.  The main concern was the impact of the Dodd-Frank regulations which are currently unclear and incomplete.  Lenders aren’t sure they are complying with the new compensation regulations.  They fear they will make a mistake and be subject to giant class action law suits.  They expect more consolidation in the industry, especially of those mortgage lenders 5^th to 20^th in size.  The top four—Wells, Chase, BofA and Citicorp– will be around in the future.  But there will be a big battle among the next largest firms to remain competitive and some of these are expected to merge.  There are great economies of scale in legal knowledge and technology.  Some people we interviewed were hankering to leave the industry to do something else because it is so tough now to compete and be profitable.  Some of the biggest concerns were the impact of shrinking Fannie and Freddie’s market share.  The market share for mortgage bankers has fallen and might disappear with the implementation of risk retention requirements. Very few firms are currently offering training and it is much more difficult for new people to enter the mortgage industry.  The cost of entry has gone from almost nothing to a minimum of $2.5 million in capital and several thousands per year in education costs to pass state and federal tests to start a mortgage bank.

The Mortgage Bankers Association is now on the defensive and facing tough regulation by Elizabeth Warren, the former Harvard law professor who is temporarily assistant secretary of the Treasury and seeking to be the director of the Consumer Financial Protection Bureau.  The MBA is still trying to dig itself out of the hole created by the wild era when subprime and no doc loans were half of production and Angelo Mozillo was the king.  Now his name is only mentioned in embarrassment.  The new king is Dave Stevens, fresh from running FHA.  Can he present a positive image of free enterprise in housing finance and shift back from the current policy of near total government regulation which some lenders call “communism”?

The U.S. is still the leading country in the world and is able to quickly adapt to new trends. With bin Laden gone and most Muslim countries actively throwing out their tyrant leaders, can the U.S. finally start winding down its three wars and help reduce its inflated deficits?  Maybe the two political parties can agree to bring down their inflated spending and finally reduce the current high level of unemployment.  This could bring recovery to housing and mortgages. But we think that likelihood is still several years off.  The mortgage industry will flounder with volume under $1 trillion for the next two years.  Repressed demand from renter households wanting to buy housing might finally push up demand in 2013.  The big risk for the U.S. is inflation and rising interest rates making housing less affordable for home buyers.  At the moment interest rates are plummeting.  Wells Fargo economist Silva expects the ten year Treasury yield to rise sharply after QE2 ends in June.

MORTGAGE MARKET SUMMARY: The DJIA fell 1.3% to 12,638 from 12,810 last week.  For the week there were 13 positive trends offset by 7 negative trends.  Mortgage applications increased 4% from a week ago.  Refis rose 6% and purchases were up 0.3%

Positive Trends

• A group of Navy Seals supervised by the CIA assassinated Osama bin Laden in his headquarters in Abbottabad, Pakistan.  President Obama made the announcement in a televised speech.  It is almost ten years since Osama directed the destruction of the Twin Trade Towers in NYC on September 11, 2001.  It is not clear yet whether this will allow our forces to exit Afghanistan more quickly.  Oil prices fell after the news.

• Two employment surveys came out on May 6 with contradictory findings. The household survey showed a 15,000 increase in the size of the labor force, an increase in the number of unemployed of 205,000 and a decline in employment of 190,000 which caused the unemployment rate for April to rise to 9.0%, up from 8.8% in March. The establishment survey showed an increase of 244,000 new employees, up from a revised 221,000 gain in March and a 235,000 gain in February.  This was higher than expected and was the biggest increase since May 2010.  The payroll survey suggests rising gasoline prices haven’t slowed the economy.  The average hourly workweek remained unchanged at 34.3 hours.  Average hourly earnings rose 0.1%, up from no change in March.  Of the two surveys, the payroll survey is the more reliable because it has a larger sample size.

• Oil prices fell below $100/barrel on May 6 to $97.84, down from $113.70 last Friday.  There has been a general slump in commodity prices reflecting in part the general economic weakness.  The S&P GSCI index of 24 commodities lost 11% this week.  Gold fell to $1,4915/oz down from $1,561/oz last week.

• Construction spending rose 1.4% in March after declining 2.4% in February.  Both private residential and nonresidential spending increased but public spending was virtually flat.

• The ten-year Treasury yield slumped to 3.15% on May 5, down from 3.29% last week.  This was the lowest yield this year and reflects the weakness in the economy.  There is much less concern over inflation with the rise in unemployment claims.

• The yield on the 30 YFRM fell to 4.71% this week, down from 4.78% last week reported Freddie Mac.  This was the lowest rate since mid-January.

• Freddie Mac reported net income of $676 million in 1Q11.  It had reported losses in 13 of the previous 14 quarters.  The improvement stems from a decline in new mortgage defaults and better results on mortgages whose payments have been modified.  For the first time in more than a year, Freddie Mac didn’t ask the Treasury for new aid.

• U.S. factory sector orders climbed for the fifth consecutive month in March and capital spending by businesses surged as manufacturers sold more to overseas markets amid weakness in the dollar.  Orders for manufactured goods climbed by 3.0% to $462.91 billion from the prior month, the Commerce Department said Tuesday.

• The share of banks willing to make consumer installment loans rose to its highest level since the first half of 1994 according to the Federal Reserve’s Quarterly Senior Loan Officer Opinion Survey.  Demand for auto loans increased, but credit cards and other installment loans remained flat while mortgage demand continued to slide.

• The European Central Bank announced a delay in raising interest rates.  They will wait until after June.

• Fed Chairman Bernanke warned Congress this week against applying overly harsh regs on the U.S. economy.

• The selection of a director for the Consumer Financial Protection Bureau is being delayed by a letter from 44 Republican senators saying they won’t confirm anyone for the post.  They claim the agency lacks accountability and its director would enjoy unfettered power.  Obama may appoint Elizabeth Warren to the post in a recess appointment which avoids the confirmation procedure.

• The Federal Reserve reported that consumer credit rose in March by $6 billion. This was the sixth straight month of increases.  Most of the increase was in auto loans but credit card usage was also up.

Negative Trends

• Initial claims for unemployment rose to 474,000 for the week ending April 30, up from 431,000 the prior week.  This was the second weekly increase in a row.  This was the highest level since back in August 2010.  The four-week moving average also rose substantially and was up four weeks in a row.  Continuing claims rose to a 3,733,000 annual rate up from a 3,693,000 annual rate and was up above where it was on April 2.

• Commercial and industrial loans at banks have grown just 1% the past year, according to Fed data.  Total loans as a percent of GDP peaked in December 2008 and are down to 45% in March.

• The ISM index of manufacturing fell to 60.4 in April from 61.2 in March. This is the second monthly decline in a row and indicates a slowdown in the economy probably stemming from increases in oil prices.

• The index of service sector activity fell to 52.8 in April from 57.3 in March reported the Institute of Supply Management.  The slower growth was caused by weakening consumer demand and price pressures for fuel and other raw materials.

• Sales of bank-owned (REO) properties hit 34.5% of the market, according to a survey of home prices through the end of April by Clear Capital, resulting in a national price drop of 4.9% quarterly and 5% year-over-year. National home prices have fallen 11.5% in the past nine months, a rate not seen since 2008.  Add short sales, where the bank allows the borrower to sell for less than the value of the mortgage, and prices have nowhere to go but down.  “With more than one-third of national home sales being REO (bank owned), market prices are being weighed down as many markets have not regained enough footing to withstand the strain of the high proportion of REO sales,” says Clear Capital’s Alex Villacorta.  This means home prices are now lower than they were in the recent trough of March 2009.

• Moody’s downgraded Bank of America’s mortgage servicing ratings because its loss prevention results have deteriorated. The agency lowered the ratings to “above average” from “strong.” BofA recently set aside $1 billion to repurchase mortgages and added $352 million to its legal expenses during the period.

• Unit labor costs rose 1.0% in first quarter 2011 over the prior quarter.  It rose 1.2% year-over-year after dropping during the prior four quarters.  This suggests some upward drift in cost-push inflation.

CONCLUSION: There was good news for the economy with the high figure for additions to payrolls, the elimination of bin Laden, the collapse in oil and gold prices, and the decline in interest rates.  Offsetting this was pessimism in the mortgage industry as it struggles with a host of unclear regulations.  Home prices are still falling and the manufacturing and servicing sectors have slowed down.  Little progress was made on the federal deficit.

Access Mortgage Research was founded in 1991 to provide research to the mortgage industry. For more details see www.accessmrc.com or phone 410-772-1161.